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Is Frontier Communications’ 14% Dividend Yield Safe?

I’ve always been a big fan of Frontier Communications (NYSE:FTR). It’s a quiet little independent telecom company that handles regional services in just a few states like Northern California, Nevada, Arizona, Utah, Minnesota and New York. It’s the classic under-the-radar play that has done very well for investors over several years — the kind of play you have to find in a specialized screen and one that also must execute its business well.

Things have gotten tough for the company, though. In its recent third-quarter report, the company told of a 30% decline in net income, and an 8% decline in revenue, led by a 12% drop in local and long-distance service revenues. Talk about a hang up! So what’s going on with Frontier and, more importantly, will its 13.7% yield remain intact?

The problem is that, like most other phone companies, Frontier is losing subscribers to cell phone service as folks cut their landlines. Residential customer count fell by 2.3% over the sequential quarter and 10% over the previous year. Business customers fell by almost the same rates. When you lose subscribers like that, you can expect to see revenue and net income get slammed as they did.

What’s hidden in these numbers is that the company bought almost 5 million landline customers from Verizon (NYSE:VZ) several quarters back and, as you might expect, that temporarily boosted revenue and earnings. Now, however, it’s comparison time and the chickens have come home to roost on those telephone wires, so to speak. The company has started new initiatives such as expanding Internet service and satellite TV services by partnering with the big players in that arena.

Still, the problem facing Frontier is that landlines are going the way of the dodo bird. They won’t disappear entirely, but the company may continue losing customers until this trend abates. We’ve already seen Frontier cut its dividend — it did so last year when it chopped it from a buck per share to 75 cents. The company had to do it because it had some big capital expenditures coming down the pike after buying those Verizon lines. Is there another cut in the company’s future?

I like to look at free cash flow to determine if a company is using too much of its assets to pay shareholders. So far this fiscal year, the company has had FCF of $1.21 billion and has paid out dividends of $560 million. That’s about a 2-1 ratio, so about 50% of free cash flow is going to dividends. That’s a perfectly acceptable ratio.

If Frontier continues to lose customers in large numbers, this dividend could be cut. However, if that happens, I don’t suspect it would be more than 50%, which means it would still pay a healthy dividend of almost 7%. Investors looking for rock-solid safety may want to avoid buying now since the future is uncertain. Holders of the stock or those watching the company and trying to decide may want to think about holding for the next two or three quarters to see what develops.

Lawrence Meyers holds no positions in any stocks mentioned.

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