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CenturyLink's Debt Reduction Strategy Is Paying Dividends

By Adam Levine-Weinberg – Aug 11, 2020 at 7:20AM

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The telecom company has strong, stable free cash flow and is using that firepower to pay down debt and rapidly reduce its interest expense.

In early 2019, CenturyLink (LUMN -2.28%) shocked investors by slashing its dividend by more than 50%. At the time, executives said that the dividend cut didn't reflect any lack of confidence in the business. Rather, management decided that it would be better for the company (and long-term investors) to focus more on debt reduction in the near term.

This decision to prioritize deleveraging -- along with a fortuitous decline in interest rates -- is already paying off in a big way in the form of lower interest expense. This long-term cost savings will in turn benefit investors a few years down the road by enabling CenturyLink to make accretive acquisitions or start returning more cash to investors again.

More steps forward

In 2019 -- the first year of its deleveraging plan -- CenturyLink managed to reduce its net debt by more than $2.5 billion.

So far, 2020 has been another busy year for CenturyLink, primarily on the refinancing front. In January, the company issued $1.25 billion of seven-year secured debt at a 4% interest rate to repay other financings. It also extended the maturities of several term loans and revolving credit facilities while reducing the interest rate margins for this debt.

A visualization of a telecom network above a city

Image source: Getty Images.

During the second quarter, CenturyLink paid down $500 million of debt. It also refinanced $1.2 billion of debt, reducing the interest rate from approximately 5.45% to 4.25% and extending the maturities from 2022 and 2023 out to 2028. The latter move will reduce annual interest expense by more than $14 million going forward.

CenturyLink isn't finished, either. Last Friday, it completed the redemption of $300 million of high-cost debt with a 6.875% interest rate. That will save over $20 million annually. It also announced that it would issue $840 million of new senior debt due in 2029 at a 3.625% interest rate. This will allow it to redeem a comparable amount of debt maturing in 2023 with interest rates above 5%. Interest cost savings from the refinancing will exceed $13 million annually.

Interest expense is plunging

Considering how aggressively CenturyLink has been reducing its debt and refinancing what remains, it should be no surprise that the company's interest costs are falling rapidly. Additionally, CenturyLink has about $10 billion of floating-rate debt. Some of that is hedged, but the majority is not. As a result, the company has benefited enormously from a sharp drop in interest rates since late 2018.

Just two years ago, CenturyLink's annual interest expense totaled $2.2 billion, implying a weighted average interest rate of about 6% on more than $36 billion of debt. In 2019, annual interest expense fell to $2 billion.

Initially, CenturyLink projected that interest expense would decline again to $1.8 billion in 2020. However, due to another big drop in interest rates this year and the company's refinancing success, management said last week that interest expense is on pace to total just $1.7 billion this year.

Solid free cash flow will enable further progress

Annual free cash flow has exceeded $3 billion since CenturyLink acquired fiber specialist Level 3 in late 2017. Despite headwinds from the COVID-19 pandemic, free cash flow appears to be on track to reach or exceed $3 billion again in 2020. In the first half of the year, operating cash flow increased 6% year over year, while free cash flow declined just 8% despite a significant step-up in capital expenditures.

CenturyLink's dividend costs the company $1.1 billion a year. Thus, with free cash flow of $3 billion or more, the company can pay down at least $2 billion of debt annually.

Looking ahead, CenturyLink has $3.7 billion of maturities between June 2021 and March 2022. It should be able to repay this debt in full using its free cash flow over the next 19 months. That would provide incremental annual interest savings of more than $200 million. There will be additional opportunities for meaningful interest cost savings between 2023 and 2025.

Four or five years from now, CenturyLink's annual interest expense may decline to just $1.2 billion or so. Along with stabilizing revenue and cost savings, that would pave the way for solid earnings and cash flow growth. With CenturyLink stock currently trading for just four times free cash flow, I'll be looking to increase my holdings of this telecom turnaround stock in the weeks ahead.

Adam Levine-Weinberg owns shares of CenturyLink. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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