Better Buy: CenturyLink vs. T-Mobile

Many investors choose AT&T (T -0.13%) and Verizon (VZ -0.73%), the two largest wireless carriers in the U.S., as their top telecom stocks -- they pay big dividends, trade at low multiples, and have wide moats. Other telecom companies, like CenturyLink (LUMN 4.17%) and T-Mobile (TMUS 0.36%), generally get less attention.

CenturyLink doesn't own a wireless business, but it became one of the world's largest wireline providers after its acquisition of Level 3 Communications two years ago. However, it lost about two-thirds of its market value over the past five years as its commercial and enterprise revenues declined.

Image source: Getty Images.

T-Mobile, the third largest wireless carrier in the U.S., doesn't own a wireline business. Its majority owner Deutsche Telekom is trying to merge it with Sprint (S), the fourth largest wireless carrier in the U.S., but the deal remains in limbo due to a lawsuit from multiple state attorneys general. All that merger buzz, along with T-Mobile's stable growth, caused the stock to nearly triple over the past five years.

T-Mobile has clearly been a better investment than CenturyLink, but will that trend continue? Let's take a closer look at both companies to decide.

Which company is growing faster?

CenturyLink and T-Mobile's customer bases aren't directly comparable, since they serve different markets. But in terms of revenue growth, T-Mobile is clearly the stronger company.

Source: Company quarterly reports. YOY = Year-over-year.

CenturyLink is struggling with the sluggish growth of the wireline market. Its acquisition of Level 3 reduced the weight of its consumer business to just 25% of its revenue and expanded its overseas presence, but macro challenges and poor pricing power are throttling its growth.

Meanwhile, T-Mobile continued to grow amid tough competition from AT&T and Verizon, thanks to 26 straight quarters of over a million net customer additions. It continued to gain customers with competitive prices and attractive perks like data-free video streaming. However, investors should note that CEO John Legere -- who spearheaded those strategies and the company's proposed merger with Sprint -- will step down in May 2020.

Analysts expect CenturyLink's revenue to decline 5% this year and drop another 3% next year. T-Mobile's revenue is expected to rise 4% this year and 5% next year, but those figures could be revised upwards if the Sprint merger is approved.

Dividends and profitability

CenturyLink cut its dividend earlier this year, but it still pays a whopping forward yield of 7.6%. T-Mobile doesn't pay a dividend.

CenturyLink's new dividend is easily sustainable, since it only used 44% of its free cash flow (FCF) over the past 12 months. However, investors' gains from those dividends were wiped out by the stock's 12% decline during the same period.

Moreover, its FCF fell 16% annually last quarter, indicating that its cash dividend payout ratio will continue rising. CenturyLink's debt-to-equity ratio is also much higher than T-Mobile's, due to recent acquisitions like Level 3, and extinguishing debt usually takes precedence over paying dividends.

CenturyLink and T-Mobile are both consistently profitable. At first glance, both companies' earnings growth seems to be decelerating -- but that's mainly due to year-over-year distortions caused by tax reform measures in 2018.

YOY = Year-over-year. Source: *Excludes certain integration expenses. **Impacted by tax reform.

Looking ahead, analysts expect CenturyLink's earnings to rise 11% this year and 9% next year as it continues to cut costs and pivot away from lower-margin equipment sales. Analysts expect T-Mobile's earnings to grow 19% this year and 20% next year, even as it matches AT&T and Verizon's prices.

The valuations and verdict

CenturyLink's forward P/E ratio of nine is much lower than T-Mobile's forward P/E of 16. However, that discount is arguably justified by its sluggish revenue growth, higher debt, and dependence on cost-cutting measures to drive its bottom line growth.

Meanwhile, T-Mobile remains a solid investment, regardless of what happens with Sprint. In short, investors who value a stock's potential price appreciation over steady dividends should buy T-Mobile instead of CenturyLink. Investors who care about dividends should stick with AT&T and Verizon instead.