If you're looking at Iowa Telecommunications Services (NYSE:IWA) as a potential investment idea, there's little doubt it's because of the 10% dividend yield attached to the shares, because the opportunity for growth is fairly remote. Since the company reported its third-quarter results Thursday morning, let's have a look.
When evaluating Iowa Telecom, earnings per share and net income are pretty much meaningless, because the company's capital infrastructure generates non-cash depreciation expenses that take a massive toll on the income statement. For that reason, looking at free cash flow makes more sense. Along with free cash flow, the metrics that I like to look at to gauge the company's performance are revenue, access lines, interest expense and coverage, and the dividend payout ratio.
Iowa Telecom's operating revenue performance was solid with a 5.1% increase, and the company managed to cut its interest expense 46% by paying down 25% of its long-term debt in the last year (primarily via proceeds from its November 2004 IPO). The decrease in interest expense has allowed the company to improve its interest coverage ratio from last year's 1.3 times operating income to 2.3 times now.
The company's free cash flow for the quarter came in at $15.5 million, which is enough to fund the company's $12.5 million dividend payment. Changes in working capital (accounts receivable, accounts payable, and inventory) aided the company's free cash flow this quarter, and the company may eventually need additional sources of free cash flow to make headway on its long-term debt balance. Such additional sources weren't needed through the first nine months of the year, however, as free cash flow was a healthy $47.7 million, which easily funded the $30.4 million in dividend payments with room to spare for debt repayment.
On an operational level, there is cause for concern because the company's access line count dropped by 1.8%. The company experienced customer losses in local telephone lines and dial-up Internet customers. The loss of dial-up customers is not a large concern, because it was more than made up for by an increase in DSL customers. The loss of access line customers however, is a concern. Anyone who invests in U.S. incumbent providers of local telephone service should expect to see falling customer counts from competition. Being a rural telecom provider, as Iowa Telecom is, offers some protection from the declines, however, because cable providers like Comcast (NASDAQ:CMCSA) aren't eager to poach customers in high-cost, low-density rural areas. Nevertheless, Iowa Telecom is losing subscribers to competition, and the question for investors is whether they can collect enough income from the company's dividend yield to earn an acceptable return before the business decline fully plays out.
Iowa Telecom is an admittedly risky proposition, which is why it bears a 10% yield. Still, a 10% yield that is more than fully funded by free cash flow is not easy to find. Iowa Telecom's yield tops most other telecom yields by a wide margin, including the 5.3% yield offered by Verizon Communications (NYSE:VZ) and SBC Communications' (NYSE:SBC) 5.5% yield. However, there are companies outside the domestic telecom market with yields that are in the 5%-8% range that have better opportunities to grow their free cash flow and their dividends. Our Income Investor service has recommended a few foreign telecoms with that dynamic, as well as a couple of REITs and energy companies that are worth consideration.
For related telco Foolishness:
SBC Communications is a Motley Fool Stock Advisor recommendation.
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Nathan Parmelee has no financial stake in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
