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3 Surprising Reasons That Windstream’s Dividend Is Safer Than You Think

By Chad Henage - Mar 4, 2014 at 12:00PM

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To suggest a company that is heavily indebted could actually support a 12% yield seems crazy, but there are 3 reasons this craziness may last.

It's a rare thing indeed when you find a 12% yield that may actually be safe for investors. When you add to the scenario that this company has a mountain of debt, and operates in a business with questionable growth potential, the argument for buying the stock gets even harder to believe. However, Windstream Holdings ( WINMQ ) is giving investors at least three reasons to believe this dividend may be safe after all.

An interest-ing improvement
Let's not pretend even for a minute that Windstream isn't heavily leveraged. The fact is, the company's debt-to-equity ratio of more than 10 puts it squarely ahead of the pack (not in a good way) when it comes to debt. Competitors like CenturyLink ( LUMN -4.46% ) and AT&T ( T -2.63% ) aren't even in the same ballpark with debt-to-equity ratios of 1.2 and 0.8 respectively.

However, not all debt is created equally and when it comes to managing this mountain of debt, Windstream is a champ. When looking at heavily indebted companies, it makes sense to look at their interest cost compared to their operating income. In theory, a company that uses a large portion of its operating income on interest could be in trouble.

If you think about it, this makes perfect sense. All things being equal, how can a company reward its shareholders if the majority of its earnings are being sucked up by interest costs? Last year this was Windstream's story as the company's interest as a percent of operating income came in at more than 90%.

Given that CenturyLink is currently spending 49%  of operating income on interest, and AT&T spends just 12%, if the story ended there, Windstream would be a laughable investment. However, the company refinanced a portion of its debt, and paid down about $200 million in the last year. These actions helped reduce the company's interest as a percent of operating income to just 45% compared to over 90% last year. To say this should draw interest from investors is an understatement.

Believable projections...who would have thought?
While many companies make projections about where they believe their results will land in the next few quarters, Windstream's current performance makes the company's 2014 projections believable.

In the current quarter, Windstream generated an amazing core free cash flow (net income + depreciation – capital expenditures) payout ratio of just 52%. I call this amazing because for multiple quarters this same calculation resulted in a payout ratio of at least 90%.

This performance allowed Windstream to actually match CenturyLink's payout ratio of 52%, and is surprisingly better than AT&T's ratio of 61%. Given that Windstream's yield is 70% higher than CenturyLink and almost 120% more than AT&T, this seemingly sustainable payout ratio gives Windstream investors a lot to like about this yield.

The current quarter did show a significant decline in both cost of services and selling, general, and administrative expenses that aren't likely sustainable. However, even with expected increases in these two costs, the company's payout ratio is expected to fall between 67% and 77% for the full year. Though this ratio isn't quite as good as the current quarter it would mark a vast improvement over prior years.

What makes the future look better?
Of course Windstream's fortunes really lie with what the company can do in the future. All the current numbers and projections in the world won't mean a thing if the company can't grow its business. This is where the difference between Windstream and some of its peers is significant.

CenturyLink and Frontier Communications both have revenue that is split nearly evenly between residential and business customers. AT&T of course gets a huge part of its earnings from wireless sales that help offset any weakness in the wireline division.

Windstream says it wants to be, "the nation's premier enterprise communications and service provider." Considering that more than 65% of Windstream's revenue comes from the company's Business division, this goal seems possible. In addition, almost 40% of the company's residential business is high-speed Internet, which is a growing business as well.

The bottom line
In the end, Windstream seems to be transforming before investors eyes. The 12% yield should get plenty of attention from income focused investors, and the company's performance seems better than many realize.

If Windstream can continue to grow its Business division and high-speed Internet businesses, the company will reach a tipping point where the importance of these businesses will override the declines in its other divisions. When that happens the company could return to real growth. Imagine that, a 12% yield with a growing company, actually don't just imagine it, consider adding Windstream to your personalized Watchlist today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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AT&T Inc. Stock Quote
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$22.23 (-2.63%) $0.60
Windstream Holdings, Inc. Stock Quote
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