Why Frontier Communications Bounced 21% in 2013

Rural telecommunications company Frontier Communications (FTR) broke its losing streak in 2013, posting gains of more than 20% after losses in 2011 and 2012 cut more than half of the value from its share price. Even though both Frontier and rival Windstream (WINMQ) managed to keep their dividend payouts stable in 2013 -- a feat that CenturyLink (LUMN -6.20%) couldn't match after its dividend cut early this year -- Frontier's recent deal with AT&T (T -1.37%) represents a doubling-down in Frontier's bet on the profit potential of the rural telecom market. Let's take a closer look at what happened with Frontier Communications this year and whether its stock will rise in 2014.

Source: National Archives and Records Administration, courtesy Wikimedia Commons

Why did Frontier stock climb higher this year?
Frontier managed to do much better than Windstream and CenturyLink this year, with Frontier having been the only one of the three to post any appreciable share-price gains to go with its huge dividend yield. But the industry got off to a slow start, as CenturyLink's decision to cut its dividend by more than 25% in February sparked new fears that its peers might have to reduce their dividends as well. Even though Windstream has managed to avoid having to reduce its payout over the years, Frontier shareholders have had to endure two dividend cuts in recent years that together have lopped 60% from its previous payout. Yet at least so far, Frontier has held the line on its dividends, with an attractive 8.5% yield continuing to draw interest from dividend investors.

More than anything, Frontier's positive move seemed to show that investors are content with the telecom's general prospects. The stock did well after both of the company's quarterly reports in the second half of the year, even though on paper, the results didn't seem all that encouraging. In November, for instance, Frontier's third-quarter report showed overall sales falling 5.3%, with roughly flat adjusted earnings from the year-ago period. Reiterated guidance for the full year suggested a double-digit drop in free cash flow, but the 13% pace of declines in capital expenses combined with net additions of broadband customers have given shareholders more confidence in Frontier's potential going forward.

Frontier Total Return Price data by YCharts

Given Frontier's extensive debt, it was surprising to see its deal last week with AT&T to acquire the wireless giant's Connecticut statewide fiber network and wireline business for $2 billion in cash . But investors pushed Frontier shares up 10% on news of the deal, based on the company's assertion the deal would boost Frontier's free cash flow within the first year after its completion. With the resulting improvement in the company's ratio of dividend payouts to free cash flow, shareholders hope not only that the AT&T deal will prevent a future cut in quarterly dividends but potentially even allow an increase at some point in the not-too-distant future.

Finding improvement on the profit and free-cash-flow fronts will be critical to Frontier's continued success. Already, Frontier has lagged behind CenturyLink in both residential and business revenue growth, raising questions about whether Frontier's overall strategy focuses enough on higher-margin business clients. At the same time, credit rating agency Fitch downgraded Frontier's debt rating from BB+ to BB, following up on its negative outlook for the rural telecom earlier this year and citing the increased leverage that Frontier will take on in financing the all-cash transaction.

Stats on Frontier Communications

Source: S&P Capital IQ

What's next for Frontier Communications?
Even before the AT&T deal, Frontier had started to see the rate at which it was losing residential customers start to slow. That points to the potential success of Frontier's strategy to get exiting landline customers to take on broadband and other services instead. With new AT&T customers coming on board, Frontier will have to duplicate its past success in retaining their business.

For Frontier to continue rising, it needs to work on improving its overall strategy toward retaining residential and business customers. During 2014, watch closely at the company's efforts to sell more services to its existing customers both in established markets and in the newly acquired Connecticut market once the AT&T deal goes through. Frontier needs to see its turnaround continue and for revenue to hit bottom in order to convince shareholders its rebound is for real.

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