It might be hard to believe that a company that not long ago had to cut its dividend could potentially be a good investment. However, based on CenturyLink's (LUMN -1.43%) recent performance, the company looks poised to outperform going forward. In fact, there are three reasons to believe that CenturyLink will return to revenue growth over the next year.
On the surface this sounds about right
It's common for many analysts to try and project a five year growth rate for the companies they follow. In CenturyLink's case, the average analyst expects the company's EPS to decline by roughly 1% over the next five years.
To most investors, this would seem to place CenturyLink's expected decline in earnings squarely between its competitors Frontier Communications (FTR) and AT&T (T -0.89%). Frontier is expected to show a decline in earnings per share of more than 10% in the next five years, whereas AT&T is expected to show roughly 6% growth. However, the business dynamics at these three companies are very different and CenturyLink may do better than analysts expect.
In the current quarter, CenturyLink's revenue was split almost evenly between the companies Business and Consumer divisions. With Business revenue up 1% and Consumer revenue down less than 2% an overall decline of 1% sounds about right. However, there is no guarantee that CenturyLink's Consumer business will continue to decline at a near 2% rate.
In the current quarter for instance, CenturyLink reported voice line subscribers declined by roughly 5%, whereas Frontier reported a nearly 9% decline, and AT&T lost more than 11% on a year-over-year basis. This is the first reason to believe CenturyLink will return to growth. The company's better voice line retention rate, and growth from services such as high-speed Internet and video, should improve CenturyLink's Consumer performance.
By the end of 2014 the tide could turn
The second reason to believe CenturyLink will return to growth has to do with the simple math of improving revenues in the company's Business division. Though the Business division represents just over half of CenturyLink's overall revenue, continued growth will change this percentage over time.
With just a consistent 1% improvement in Business revenue and a continued decline of less than 2% in the Consumer division, in roughly four quarters CenturyLink's overall revenue would change from a slight decline to flat on a year-over-year basis.
In fact, this is a significant difference between CenturyLink and Frontier. In the last three months, Frontier reported Residential and Business revenue both declined by 5%. AT&T, on the other hand, had its huge wireless division report revenue growth of just under 5%, helping offset a revenue decline of more than 1% in the company's wireline business.
When you look at these numbers, it's fairly easy to understand why analysts expect Frontier to report negative earnings, AT&T to report growth, and CenturyLink to fall somewhere in the middle.
The third reason to believe in CenturyLink's return to growth has to do with the company's projections for free cash flow in 2014. CenturyLink expects free cash flow to fall between $2.6 billion and $2.8 billion for the full year. By comparison, in the last 12 months the company's core free cash flow (net income + depreciation-capital expenditures) came in just shy of $2.5 billion.
While it's true that CenturyLink is guessing, the company's Business and Consumer performance seems to suggest a potential improvement. Considering that CenturyLink's core free cash flow payout ratio was just over 52% in 2013, if the company delivers on its 2014 promises this payout ratio should be stable or a little lower.
While AT&T's dividend seems to be well covered with a core free cash flow payout ratio of just under 61%, the company's 5.5% yield can't match CenturyLink's 7% payout. Where Frontier is concerned, the company's current yield of better than 8% seems less safe with a payout ratio of almost 67% and more severe revenue declines across the board.
The bottom line is CenturyLink is poised to return to growth potentially by the end of this year. Investors looking for a well-supported high-yield stock should look no further.