Windstream (NASDAQ:WIN) is a great example of a company where the reward is potentially great, but the risk may be greater. In just a few weeks, investors will get a chance to study the company's earnings results and there are three things the company must do if its substantial dividend is going to remain intact.
This sounds like a great plan
In the world of local telecommunications companies, there are three different companies that get a lot of headlines. While Frontier Communications (NASDAQ:FTR) pays a nice yield, and CenturyLink grabbed headlines with a recent $1.1 billion writedown, Windstream might get the most press because of its dividend.
The challenge for investors is to determine if Windstream's yield is like a mirage in the desert and destined to disappear. You can almost hear the Windstream investors' mantra, "even if the stock goes nowhere I still get a better than 13% yield!"
If Windstream is going to continue paying its fat dividend, the first thing the company must do is continue on its mission as CEO Jeff Gardner put it, "to transform Windstream into an enterprise-focused company." Given that enterprise spending has been resilient, it makes sense for the company to focus on this sector.
In the company's earnings report in November, Windstream said that enterprise customers grew by 6% and made up more than 30% of total business customers. The company needed this enterprise growth because its small business customer base shrank by 9%.
However, even with total business customers declining by 5%, the company increased business service revenue by 1%. Though this growth didn't keep pace with Verizon Communications (NYSE:VZ) business revenue growth of 2.3%, Windstream did better than Frontier which reported a 5% decline.
Since business service revenue represented more than 60% of Windstream's total revenue, continued growth in this business is critical to the company's earnings and cash flow.
Any improvement would be a welcome surprise
The game plan for most telecommunication companies is to grow their high-speed Internet and video subscribers fast enough to offset voice line losses. Unfortunately, someone forgot to tell Windstream's consumers this was the idea.
In stark contrast to its peers, Windstream witnessed declines of between 3% and 5% in its high-speed Internet and video businesses. By comparison, Frontier reported high-speed Internet additions grew by 5%, and video subscribers increased by 15%. Verizon also reported strong growth with its FiOS platform reporting better than 11% growth in both services.
The second thing Windstream needs to do to maintain its dividend is improve its consumer retention. Though the consumer business only represents about 20% of the company's total revenue, any improvement in Windstream's high-speed Internet, video, or voice businesses would be a welcome improvement.
This isn't pretty
The third thing Windstream must do in its next earnings report is show that the company is committed to improving the balance sheet and the company's interest expense. In the last quarter, Windstream made sure to mention that it refinanced some of its debt and should realize about $45 million in interest savings over the course of 2014.
Windstream carries over $8.7 billion in net long-term debt, and has a debt-to-equity ratio north of 10. To put this in perspective, Frontier's debt-to-equity ratio is just over 2, and Verizon's ratio is less than 1. That being said, Windstream's interest isn't killing the company yet.
In the last nine months, Frontier reported troubling numbers when it comes to core free cash flow (net income + depreciation-capital expenditures) compared to interest paid. The company generated about $450 million in core free cash flow and yet paid about $500 million in interest.
On the other end of the spectrum, Verizon paid about $2.7 billion in interest, but generated over $23 billion in core free cash flow in the last 12 months. By comparison, Windstream paid about $480 million in interest and generated $457 million in core free cash flow. While Windstream's debt refinancing should help, the company must continue to cut its interest costs or the dividend may not survive.
Chasing a high yield can be dangerous, but Windstream's path to continue its dividend is fairly easy to track. In just a few weeks, investors will get more information on the company's results. If the company can reassure its investors the dividend is safe, this could be a major WIN for investors.
However, if Windstream stumbles the dividend could be in trouble. If you want to know what happens when a high-yield dividend gets cut, just ask Frontier and CenturyLink investors, it's not a pretty sight.
Chad Henage owns shares of Verizon Communications. The Motley Fool has no position in any of the stocks mentioned. 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.