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3 Reasons This 7% Yield Is Safe

By Chad Henage – Mar 24, 2014 at 12:00PM

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There are few 7% or better yielding stocks, and even fewer that have a yield that should be sustainable. CenturyLink is a rare breed that pays a high yield and the dividend may grow yet again.

It's not every day that you come across a stock with a 7% yield. With CD and bond yields near record lows, income hungry investors would love to find a company that could sustain this type of payout. Ironically, the company these investors should consider is CenturyLink (LUMN 3.52%) which was forced to cut its dividend last year. In fact, there are at least three reasons to believe that this yield is safe and could potentially grow once again.

Sometimes it really is this simple
In an industry where even stable revenue is considered a victory, CenturyLink is closer than several of its peers to delivering on revenue growth. The company counts among its peers companies like Frontier Communications (FTR) and AT&T (T 0.89%).

CenturyLink and Frontier both separate their businesses into residential and business divisions. AT&T of course divides its results into wireless and wireline. The good news for CenturyLink is no matter how you cut it, the company is doing better than these competitors when it comes to consumer and business revenue.

This brings us to the first reason CenturyLink's 7% yield is safe, the company's consumer revenue decline is improving. In the current quarter, the company reported consumer revenue declined by 1.7% compared to a 1.6% decline at Frontier and a 3.4% overall wireline decline at AT&T.

More importantly, CenturyLink's consumer revenue decline was smaller than last quarter's 2.1% drop. Though this improvement doesn't sound like much, in an industry where voice line losses are rampant, getting closer to breakeven is a big accomplishment.

CenturyLink's business performance was even more encouraging. The company reported business revenue increased 1%, compared to a 4% decline at Frontier and again the more than 3% decline from AT&T. As the company's business revenue continues to grow, and its consumer losses flat line, the company could deliver overall revenue growth. To sustain the dividend, real top-line growth is critical.

Stability is key
Some investors might look at CenturyLink's operating margin compared to its peers and wonder is this isn't just a middle of the road operator. After all, Frontier sports a much higher margin at nearly 22% compared to CenturyLink at just under 15%.

While AT&T's wireline margin is just 10%, the comparison is a bit unfair because the company is heavily focused on its wireless business. That being said, the second reason CenturyLink's dividend looks safe is the company's operating margin seems to have stabilized. In fact, the company reported the same 14.8% operating margin in the prior quarter as it did in the last three months. Combined with the potential for real revenue growth, this would provide growth in net income to help support the dividend.

A painful past, but a brighter future
When CenturyLink announced its dividend cut last year, it was a painful pill for investors to swallow. The stock took at better than 20% hit and some questioned if the company's choice to reallocate funds toward share repurchases was the right move.

However, CenturyLink was just facing reality. The company had been using up its tax benefit from prior losses, and with this reversal needed to make a hard decision. The good news is, shareholders have seen the company retire about 6% of the company's outstanding shares over the last year.

This brings us to the third reason the company's dividend looks safe. CenturyLink's free cash flow seems to be improving. In the last three years, the company's average core free cash flow has been nearly $2 billion per year. However, during this time the company was paying over $1.5 billion a year in dividends for a better than 80% payout ratio.

In the last year, CenturyLink's average payout ratio has dropped to about 57%. Compared to core free cash flow payout ratios of 62% at Frontier, and 61% at AT&T, this number already looks good. With CenturyLink projecting stable free cash flow or a slight increase in full year 2014, the company's payout ratio could improve.

CenturyLink shows the potential for revenue growth with a stable operating margin. With projections for free cash flow that would generate a less than 60% payout ratio for 2014, investors should have confidence in the current yield.

If the company can grow its net income, CenturyLink could get the dividend back on a growth track. A 7% yield with the potential for growth should make CTL one of the first stocks income-hungry investors add to their personalized Watchlist.

Chad Henage owns shares of CenturyLink. The Motley Fool has no position in any of the stocks mentioned. 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.

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