In recent years, Lumen Technologies (LUMN 1.63%) -- formerly known as CenturyLink -- has consistently been one of the highest-yielding stocks in the S&P 500. That has made it extremely popular with income investors.
The telecom giant has been a bad dividend stock over the past 10 years, though. For one thing, the company slashed its payout by more than 50% in early 2019. Moreover, its share price has tumbled more than 60% in the past decade, giving it a total return of -15% over that period.
Lumen stock performance, data by YCharts.
Lumen's long-suffering shareholders had reason to celebrate this week, though. On Wednesday afternoon, the company reported a big earnings beat for the third quarter. It also gave investors more clarity about its aggressive investment and capital allocation plans. This caused the dividend stock to soar 13% on Thursday.
Another earnings beat
Lumen has repeatedly beaten analysts' earnings estimates in recent quarters. However, Lumen stock hasn't benefited much, because the company's revenue has declined steadily.
The third-quarter earnings report followed this typical pattern. Revenue fell 5.4% year over year to $4.89 billion: roughly in line with the analyst consensus. Lumen offset some of that revenue decline with cost cuts, though. Excluding special items, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) slipped just 2.5% to $2.08 billion.
Moreover, Lumen's adjusted earnings per share (EPS) skyrocketed 40% to $0.49, crushing the average analyst estimate of $0.38. To be fair, lower depreciation and amortization expense associated with two pending asset sales likely accounted for most of that discrepancy. Nevertheless, the magnitude of the earnings beat was impressive.
Management takes a combative tone
Three months ago, Lumen announced a pair of massive asset sales. The company plans to sell its Latin American assets to Stonepeak for $2.7 billion and its traditional telecom business in 20 U.S. states to affiliates of Apollo Global for $7.5 billion. Combined, those assets generate about 20% of Lumen's adjusted EBITDA, so selling them will reduce its earnings and free cash flow.
Image source: Getty Images.
Adding to the pressure on free cash flow, these sales will use up the rest of Lumen's deferred tax assets, leading to higher cash tax expense going forward. Meanwhile, Lumen plans to ramp up the expansion of its fiber-to-the-home broadband initiative, which will drive capital expenditures higher.
Due to this triple-whammy, management hinted in August that Lumen might have to cut its dividend again next year. However, on Wednesday, they changed their tune, saying that while Lumen's payout ratio will rise in the near term, the company plans to continue its quarterly dividend of $0.25 per share anyway.
In an equally bold move, Lumen completed the entire $1 billion share repurchase program it announced in August by early October. It bought back nearly 81 million shares, reducing its share count by over 7%. CEO Jeff Storey also hinted at the potential for additional buyback programs in the future.
A risky financial strategy
The announcement that Lumen plans to maintain its dividend probably drove the bulk of the stock's 13% gain on Thursday. The aggressive buyback also likely pleased some shareholders, as it points to management's confidence in the business.
That said, some analysts were skeptical of these moves to return more cash to shareholders rather than continuing to focus on debt reduction. In particular, Bank of America Merrill Lynch analyst David Barden noted that focusing on dividends and buybacks rather than debt management has had disastrous consequences for other companies with heavy debt loads and persistently declining revenue. Indeed, management's new capital allocation plan definitely makes this dividend stock even riskier than it was before.
Lumen Technologies financial debt (quarterly), data by YCharts.
Will the fiber investment plan succeed?
Ultimately, the success of Lumen's plan to dramatically expand its consumer fiber business will likely determine whether management's decision to maintain the dividend and buy back stock pays off. Today, Lumen has about 2.7 million fiber-enabled homes (nearly all of which are in the states not being sold to Apollo). Recently, it has been expanding its fiber footprint by about 400,000 homes annually.
This expansion appears to be paying off. In the first nine months of 2021, Lumen grew its consumer fiber subscriber base by 15% (from 675,000 to 774,000), while average revenue per user increased from $56 per month to $59 per month.
By the end of 2022, Lumen plans to start expanding the number of fiber-enabled homes at a pace of 1.5 million to 2 million units annually. That would allow it to reach its addressable opportunity of 12 million-plus homes within six years or so. At Lumen's assumed penetration rate of 40%, the company would have perhaps 5 million fiber broadband customers, adding billions of dollars to its top line.
This plan is certainly plausible. And if it succeeds, it should drive solid revenue and EBITDA growth for Lumen. That would enable it to support its debt with ease -- and it would likely send the dividend stock soaring. But if Lumen doesn't make the market share gains it expects, the company's risky capital allocation strategy could lead to a crisis a few years from now.
