What happened
Shares of telecom giant Lumen Technologies (LUMN) were rising on Tuesday, at one point up 5%, before reverting to a 1.9% gain as of 2:28 p.m. ET. However, that was still ahead of the broader indexes at that time.
Like many stocks, Lumen rose on the back of this morning's cooler-than-expected inflation report; however, unlike other stocks that made above-market gains, Lumen isn't a high-growth stock. Rather, it has another quality that would also benefit from lower-than-expected interest rates.
So what
Besides growth stocks, heavily indebted companies would also benefit handsomely from lower interest rates. This is because heavily indebted companies not only need a strong economy to deliver operating profits to service their debt, they also will likely need to refinance existing debt when it comes due.
Lumen certainly has a lot of debt, to the tune of about $25 billion between its short-term and long-term notes. That's about 3.6 times management's estimate for this year's earnings before interest, taxes, depreciation, and amortization (EBITDA).
That's not necessarily that high for a telecom stock like Lumen; however, what makes Lumen riskier is that it is currently facing revenue and profit declines at the company level, as shrinking legacy technologies are currently outpacing the smaller portions of the company that are growing. That's different from its sector peers, which generally have more stable, if not very high, revenue and earnings growth. Lumen even had to cut its dividend last month in order to de-risk its business, and it has a new CEO coming into the role in Kate Johnson, who will be succeeding Jeff Storey.
Of course, Lumen's net debt is about to come down further, as it just closed the sale of its incumbent local exchange carrier (ILEC) business across 20 U.S. states, and announced another asset sale of its Europe, Middle East, and African business, which will likely close next year. Those deals will bring in billions in cash to Lumen, which will help bring down leverage.
However, it's not so simple, as Lumen will also lose the EBITDA and cash flows associated with both of those businesses; moreover, Lumen's new strategy entails investing in next-gen tech products with good growth prospects, such as high-speed fiber broadband. That will consume some of the capital coming in from the asset sales.
So, Lumen will still be a levered company based on its future profitability, even after these asset sales. That means it will likely have to refinance its debt in the future, and it will need a strong economy to cultivate its newer "growth" products.
So, like high-growth tech stocks, Lumen would also benefit from lower interest rates. That's why the stock is rallying on the back of today's lower-than-expected inflation report. Lower inflation signals to the Federal Reserve that its rate hikes have begun working. Therefore, this morning's number signals the Fed may be able to stop raising rates sooner.
Now what
Despite the good day, Lumen remains a risky stock, although it is quite cheap. The stock currently trades at less than 3 times its projected 2022 free cash flow, making it a deep value stock.
However, Lumen's high debt load means its enterprise value is much higher. Furthermore, if the new CEO doesn't manage to stem overall revenue and profit declines, the stock could fall further, as questions about Lumen's solvency would no doubt surface at that point.
On the other hand, if Johnson can successfully turn around the business, the stock could soar, given its highly leveraged status and low equity multiple. Fortunately, it looks as if inflation and interest rates are helping her cause, at least for today.
