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Better Buy: CenturyLink vs. AT&T

By Herve Blandin - Feb 18, 2020 at 8:30AM

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Both telecommunication providers pay a generous dividend despite their risky transformations and significant debt loads.

AT&T (T 1.27%) and CenturyLink (LUMN 0.72%) produce free cash flow that more than covers their generous dividends. But both telecommunication giants must succeed in their transformation to compensate for the secular decline in some of their businesses. They must also reduce their debt loads, which are significant, to sustain their returns to shareholders. CenturyLink offers a much higher dividend yield, but is it a better choice than AT&T for investors looking for safe income over the long term?

AT&T: Significant execution risks

AT&T's communication business remains stable. Revenue from the company's mobility segment, which includes services and equipment, increased by 0.8% year over year to $18.7 billion during the last quarter. But AT&T is also facing challenges with its entertainment activities. Because of the shift to online video streaming, the company lost 945,000 premium TV subscribers during the last quarter, lowering that total to 19.5 million.

As a result, revenue from its entertainment group segment dropped by 6.1% year over year to $11.2 billion, and total revenue decreased by 2.4% to $46.8 billion compared to $48 billion a year ago.

With 5G and HBO Max (online video streaming AT&T will launch in May), management expects low single-digit revenue growth over the next few years, though. It also forecasted the company's annual free cash flow to exceed $30 billion, which would more than cover the $15.2 billion dividend.

That doesn't mean AT&T will become a safe dividend stock, though. Its debt load of $151 billion at the end of 2019 remains important, and management plans to further reduce it over the coming years with free cash flow and assets divestitures.

Besides, this outlook depends on the success of HBO Max. Granted, AT&T will profit from unique cross-selling opportunities between its rich content and its huge distribution channels (170 million direct customer relationships across mobile, pay-TV, and broadband, and 5,500 retail stores). But launching such a new entertainment offering brings with it important execution risks for the telecommunications conglomerate. And HBO Max will compete with Disney's Disney+, Comcast's Peacock, and Apple's Apple TV+, among others, to try to make a dent in Netflix's dominance in the online video streaming market. 

A cityscape at night with many connected glowing dots representing a network

Image source: Getty Images.

CenturyLink: Fiber is the future

CenturyLink sells telecommunication services to consumers (broadband and voice) and enterprises (communication infrastructures and professional services). But with the development of Internet-based communications, some of these services (such as fixed telephone lines) are becoming less and less relevant. 

Management has been focusing on increasing the company's margins to offset declining revenue and keep EBITDA (earnings before interest, taxes, depreciation, and amortization) stable. For instance, the company is exiting low-margin contracts. Thus, despite the 4.4% decline in revenue in 2019, adjusted EBITDA stagnated at $9.07 billion. And adjusted EBITDA should reach $9.1 billion in 2020, based on the midpoint of guidance.

Taking into account capital expenditures, free cash flow should land in the range of $3.1 billion to $3.4 billion this year, which represents approximately three times the $1.1 billion annual dividend. But the company must use its free cash flow to continue reducing its debt, which decreased to $33.3 billion -- net of cash -- at the end of last year, from $35.9 billion a year ago.

Besides, the strategy of focusing on higher-margin businesses to offset revenue decline can't last forever. CenturyLink must transform its core business to stabilize -- and eventually grow -- its revenue, and fiber is at the heart of this transition. This technology is poised to grow as an essential element in modern telecommunication infrastructures thanks to its capacity to transport large volumes of data at high speed over long distances. For instance, 5G will require a high density of antennas hosted in sites that must connect to a core network via performant connections that fiber can offer.

Thus, CenturyLink's success depends on its capacity to develop its fiber assets, which remains in the scope of its core telecommunications business. In contrast, AT&T's bet in online video streaming against increasing competition involves greater execution risks. And given CenturyLink's higher dividend yield of 7.2% compared to AT&T's 5.4%, dividend-oriented investors should consider prioritizing CenturyLink over AT&T.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple, Netflix, and Walt Disney. The Motley Fool recommends Comcast and recommends the following options: long January 2021 $60 calls on Walt Disney and short April 2020 $135 calls on Walt Disney. The Motley Fool has a disclosure policy.

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Stocks Mentioned

AT&T Inc. Stock Quote
AT&T Inc.
T
$18.27 (1.27%) $0.23
Lumen Technologies Stock Quote
Lumen Technologies
LUMN
$11.23 (0.72%) $0.08

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