With a yield of more than 7%, Lumen Technologies (LUMN -5.15%) is a popular stock among investors looking to generate reliable income. Thanks to its bargain valuation and a multiyear campaign to pay down debt (and reduce interest expense), Lumen stock also holds significant capital-appreciation potential.
However, Lumen's revenue has been falling slowly but steadily for years, and that trend continued last quarter. Until Lumen proves to investors that it will be able to stabilize its revenue -- or better yet, return to growth -- the stock will likely struggle to break out.
Lumen Technologies revenue (annual), data by YCharts.
The revenue downtrend continues
In the first quarter of 2021, Lumen's revenue slumped 4% year over year to $5.03 billion, falling just short of the analyst consensus of $5.06 billion. This result was roughly consistent with the 3.5% full-year revenue decline the company logged in 2020.
At its analyst day last month, Lumen noted that while it's investing for growth in some areas, it's managing other businesses for cash. The latter category mainly consists of the telecom company's declining legacy voice operations, as well as its lower-margin wholesale business.
Nearly 90% of Lumen's revenue decline last quarter came from the businesses it's managing for cash. Unfortunately, revenue also declined -- albeit very slightly -- for the rest of the company -- i.e., in the businesses where it says it's investing for growth. Lumen does have attractive growth opportunities in markets like edge computing and fiber internet connections, but for now, it's struggling to capitalize on those opportunities.
Profitability holds up nicely
In recent years, cost cuts have enabled Lumen to post solid earnings results despite its revenue declines. Last quarter, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) slipped just 2% year over year to $2.17 billion. The company's adjusted EBITDA margin expanded to 43.1% from 42.3% a year earlier.
Furthermore, Lumen continued to benefit from significant interest-expense savings, thanks to its moves to reduce its debt and opportunistically refinance other borrowings at lower interest rates. Interest expense decreased $60 million year over year. Other income also improved compared to the first quarter of 2021. As a result, adjusted earnings per share surged 26% year over year to $0.44, beating the average analyst estimate of $0.40.
Image source: Getty Images.
Finally, free cash flow continued to exceed book earnings. Lumen generated $809 million of free cash flow last quarter -- $850 million excluding special items -- easily exceeding its net income of $475 million.
Patience could pay off
Lumen stock trades for around eight times the company's projected 2021 earnings and five times its full-year free cash flow guidance of $2.8 billion to $3 billion. That rock-bottom valuation means there's a ton of upside for the stock if Lumen can get its revenue growing again.
In the meantime, investors can afford to be patient. First, Lumen's low valuation provides a margin of safety in case revenue continues declining over the next several years.
Second, Lumen is well-positioned to reduce interest expense further. In the first quarter, it used some of its free cash flow to repay $235 million of debt carrying a 7% interest rate. It also refinanced $900 million of debt, lowering the interest rate from 5.375% to 3.75%. And between now and the middle of 2022, it will have opportunities to repay or refinance over $6 billion of debt that currently carries an average interest rate of more than 6%.
Falling interest expense should support earnings growth, even if Lumen's top-line performance remains weak. Debt reduction also inherently makes the company a less risky investment. As a result, investors can feel fairly comfortable holding Lumen stock, enjoying its high dividend payout, and waiting for a potential revenue turnaround that could drive the shares much higher.
