4 Reasons To Buy CenturyLink Despite Current Issues

It's all too easy to write off an industry as doomed for extinction and just ignore all of the companies that are connected to said industry. One industry that many investors seem to ignore is the local telecommunications business. The assumption is that customers are fleeing landline connections, so why invest in a dying industry? While landline connections are dropping, there are significant differences between the major players; CenturyLink (LUMN -6.20%) could be the best of the bunch.

The data-hosting elephant in the room
No matter the size of the company, $1 billion is a lot of money. When CenturyLink said it would take a non-cash $1.1 billion goodwill impairment on its data hosting business, many investors sold first and asked questions later.

Competitors like Frontier Communications (FTR) and Windstream (WINMQ) are also attempting to gain business in data hosting and hoping that an enterprise focus will allow them to prosper in the future. With CenturyLink taking this writedown, investors should worry about the company "not currently achieving the forecasted growth and cash flows we originally projected."

This isn't to say that the hosting business is a lost cause; it's just a crowded industry with many large players trying to take a piece of the pie. It appears that CenturyLink's management made some assumptions and wasn't able to produce these results. No doubt this is a worry, but is it enough to avoid the stock?

A minor but important victory
The first reason to buy CenturyLink has to do with the company's performance in retaining landline subscribers. Everyone knows that traditional landline connections are dropping as customers choose wireless or voice-over-IP connections instead. Since the landline business is a cash cow for local telecoms, maintaining these connections for as long as possible is important.

CenturyLink scored a minor victory when it comes to landline losses in the current quarter. Relative to its peers, the company reported a slower loss rate of 5.7% year-over-year, versus a 6 % decline at Windstream and an 8.7 % decline in voice minutes at Frontier.

An overlooked measure of risk
The second reason to consider buying CenturyLink has to do with the company's level of interest risk relative to its peers. The local telecom business is capital intensive and each of these companies carries billions in debt.

The difference between these three companies is that one pays relatively less interest than its peers.

Source: SEC filings.

The more a company spends on interest, the less there is left over for things like capital expenditures, dividends, and share repurchases. Since CenturyLink is using significantly less of its operating income on interest, the company's cash flow should be better as well.

More of this...
The third reason to buy CenturyLink is connected to the company's free cash flow generation. Since CenturyLink and its peers pay yields of 7% or more, their ability to afford these payouts is paramount to investors. One way to rank these companies based on performance is by comparing the amount of free cash flow generated by each dollar of sales.

Using each company's core free cash flow (net income + depreciation – capital expenditures) and comparing to current quarter's sales gives us a clear picture of the company that generates relatively more free cash flow.

Source: SEC Filings.

With more free cash flow per dollar of sales, CenturyLink investors should be more confident in the company's dividend relative to Frontier or Windstream.

...means less of this
As you might imagine, CenturyLink's superior core free cash flow translates into a better payout ratio for the company as well. In the current quarter, Windstream generated a core free cash flow payout ratio of 97%. By comparison, Frontier's payout ratio was 67%. CenturyLink beat them both with a ratio of just over 51 %. With the lowest payout ratio of the three, this is the fourth reason investors should consider adding CenturyLink to their portfolio.

In this supposedly "dying" industry, CenturyLink looks more lively than its peers. The company is shedding landline subscribers at a slower rate, and it pays relatively less in interest as well. When you combine these positive factors with better free cash flow generation and the lowest payout ratio of the group, it seems that the company is giving investors plenty of reasons to consider making the call to buy CenturyLink.