Income-hungry investors are being starved by low yields on Treasuries. Luckily, the strong returns offered by high-yielding telecom stocks can be a safe alternative. Telecoms generate stable earnings; however, investors should avoid overpaying in pursuit of high yields. That's because a yield that looks stable can quickly deteriorate. Let's peer into the world of domestic telecoms to see if Frontier Communications
Pushing the outer limits
Frontier's telecom services include local and long distance voice plans, data and Internet hosting, access and delivery services, and video and television programming. The traditional telephone company is braving new frontiers by expanding into Internet and broadband.
During the second quarter of 2011, the company reported an impressive 167% year-over-year rise in high-speed Internet customers, closing the quarter with 1.7 million U.S. customers.
Aside from its 12.4% dividend, Frontier offers investors a payout ratio of 469% -- scary when you realize that number means that the company is paying out nearly five times as much as it earned over the past 12 months. That sky-high payout ratio makes it seem as though it'll be harder for Frontier to sustain its large payouts in the future.
But because telecoms are plagued by high depreciation costs, earnings aren't always the best metric to use in determining dividend sustainability. The free cash flow payout ratio gives us a more accurate depiction of whether the company has enough cash to cover its generous dividends. Frontier's 109% FCF payout ratio still looks high, but not nearly as ugly as its earnings-based counterpart.
How does the competition measure up?
To put those figures in context, let's look at similar numbers for Frontier's peers:
Earnings Payout Ratio
FCF Payout Ratio
Sources: Yahoo! Finance, S&P Capital IQ.
While all of the stocks mentioned here pay generous dividends, Verizon looks the safest thanks to strong income and a manageable payout plan. CenturyLink gets a star in my book for consistently paying dividends for 37 years running, although the company's payout ratios aren't as low as Verizon's, especially on the earnings side.
All said, Frontier has generated nearly enough free cash flow over the past 12 months to cover its expensive dividend. Frontier expects to triple the size of its company with last year's acquisition of Verizon's local operations in 14 states. Strategic acquisitions have helped the company boost its free cash flow, through increased subscribers and cost savings. Continuing free cash flow growth should allay any concerns of its FCF payout ratio being too high.
The edge of reason
At first glance, Frontier's high payouts make it look like the company's biting off more than it can chew, but recent mergers and improved cash flow should put the stock back on safer ground. I think Frontier's a great buy for investors looking for an attractive yield play.
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Fool contributor Tamara Rutter does not have a financial position in any of the companies mentioned in this article. Follow her on Twitter @TamaraRutter for more Foolish coverage. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.