by Ivan Martchev | July 11, 2012 1:04 pm
The process behind the topics of my missives usually isn’t a complicated one. A friendly email request arrives with the topic in order a) to gauge my interest and expertise in the matter and b) if I can deliver it by the required date.
While I’m always interested in how the markets are doing, deliveries sometimes are a work in progress when juggling projects. Anyone who has ever worked in publishing knows that soft deadlines don’t work (as people tend to push them), while hard ones produce miracles.
This soft deadline was about the conundrum of falling telecom shares in the rest of the world and the remarkable resilience of those at home. Having spent some time recently kicking the tires on telecom stocks in the S&P 500, I thought this was a great topic.
On June 1, the U.S. 10-year Treasury note hit an all-time low yield of 1.44%. While this is not the only reason why (some) U.S. telecoms are resilient in the present environment, it has been a major driver of telecom shares (and other high-yield sectors). Bond investors looking for safer yield now dabble in BBB corporates and dividend stocks, as Treasuries and AA and A bonds simply do not offer enough interest.
Still, the resilience in the U.S. telecom sector is centered around companies with growth initiatives in wireless broadband and fiber-to-the-home parts of the market, and smaller players have been anything but resilient. Frontier Communications (NASDAQ:FTR) and Windstream (NASDAQ:WIN) have been on a slow slide for a while, given their reliance on rural landlines, which are slowly eroding.
Bigger telecoms like AT&T (NYSE:T) and Verizon (NYSE:VZ) too have land-line businesses, but they also have seen a massive surge in wireless data traffic as smartphones are becoming the must-have pocket computers. With the roll-out of 4G LTE — the true 4G standard — usage per user also is rising as faster speeds compel people formerly fed up of waiting for their 3G phones to respond.
As I stared at the payouts table that Bloomberg conveniently updates every month for all the members of the S&P 500, I remembered an article a former colleague once wrote about dividend stocks — “The 10% Club.” Shortly after his article came out, several of the featured dividend payers cut their dividends by half, and we gave him a good pestering by joking how expeditiously the 10% Club can become the 5% Club.
It is true that share prices usually decline in anticipation of a dividend cut — analysts watch cash flows, not payout ratios, to gauge the ability of a company to pay a dividend — as it has become clear that the dividend rate is unsustainable. Still, was this the case with Frontier and Windstream?
Both companies say they now have the money to pay the double-digit dividends despite horrific payout ratios. On the payout ratio front, all telecoms look bad, but that simply decreases the double taxation of dividends (which are paid from after-tax earnings) if the companies have the cash flow to pay them.
|Name||Ticker||Yield (%)||Dividend ($)||Ratio (%)|
|Source: Bloomberg (as of 5/31)|
Frontier already has cut its dividend from 25 cents per quarter to 10 cents in the past two years, so the writing has been on the wall for a while. It looks like it can maintain the lower dividend based on the cash flow generation of the business, but the share price erosion has been brutal and inappropriate for dividend investors seeking principal protection. (Dividends are not quite like bond interest where if things are half-bad, you are about to get the value of your principal returned to you 100 cents on the dollar upon maturity.)
Windstream has maintained the present dividend rate for nearly six years. It is in better shape than Frontier, but it has similar issues in its overall business.
Another company that offers a higher yield in the telecom space — in addition to AT&T and Verizon — is CenturyLink (NYSE:CTL). CenturyLink is much bigger and appears to be a more advanced company than either FTR and WIN in that it has less reliance on landlines. The company recently has extended debt maturities utilizing super-low rates, which theoretically leaves more money for running the business and paying a 7.5% dividend.
Later this month, we’ll discuss foreign telecoms.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds a position in AT&T Inc. and Verizon Communications Inc. for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities.
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