What happened
Shares of Lumen Technologies (LUMN -0.75%) were soaring Thursday, up as much as 16.9% before settling into a low-teens gain, following the release of third-quarter earnings after hours on Wednesday. The telecom company came into earnings at a very low valuation, so a few updates to guidance and some positive commentary regarding share buybacks and its dividend sent the stock soaring.
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So what
In the third quarter, Lumen actually posted a 5.4% revenue decline, missing expectations, but its adjusted earnings per share of $0.49 beat expectations by a lot, as the company was able to manage costs and generate strong free cash flow.
Lumen has been experiencing declines in legacy technologies as it invests in fiber and other modern tech, which explains the declines. But the company did report growth in its large enterprise and international segments on a sequential basis, suggesting things may be turning a corner. The company also raised its free cash flow guidance for the year from a range of $3.1 billion to $3.3 billion, to a range of $3.6 billion to $3.8 billion, as a result of more efficient capital expenditures this year.
More surprising was that the company bought back stock for the first time in recent memory. Actually, it bought a lot of stock: about $1 billion, or nearly all of its quarterly free cash flow. Due to the company's low valuation, that was good enough to reduce shares outstanding by about 7%.
Perhaps most importantly, management also reiterated it would be maintaining its dividend while still investing for growth. Previously, management hinted that it might cut the dividend after it divests certain assets next year. Management also gave a two- to three-year target for a return to top-line growth, which it hadn't done until Wednesday's conference call with analysts.
Now what
Buybacks, investing for growth, and maintaining the dividend are all big positives, but will take lots of cash. Meanwhile, Lumen is still heavily indebted, with about $30 billion in debt.
Management said it would now delay its de-leveraging plans, keeping its current leverage and instead using cash for growth investments and maintaining capital returns to shareholders. To its credit, management has paid down about $7 billion since the Level 3 acquisition exactly four years ago, and its pending asset sales set to close next year should bring in some cash as well.
Investors cheered the change in capital allocation strategy, and that seems warranted. Still, they should be careful that Lumen is now willing to maintain higher debt levels than it was previously, all while it invests in a turnaround and continues to pay a high dividend. If interest rates rise, that adds some risk.
Still, the stock is undoubtedly cheap at just over four times free cash flow, using its updated 2021 guidance. So there could still be lots of upside if management hits its targets in a couple of years.
