Centurylink Inc (NYSE:CTL) is one of the most controversial high-yield stocks on Wall Street. Some folks see it as a huge opportunity because CenturyLink stock offers a 13% dividend yield. That’s certainly worth paying attention to.
On the other hand, many see CenturyLink stock as a classic value trap. The company has struggled for years. Not all the blame falls to CenturyLink’s management; their whole sector has struggled as legacy telecom businesses continue to fade in relevancy to today’s consumer.
However, the merger with Level 3 Communications offers CenturyLink the chance to pivot toward more robust markets going forward. Add it all up, and is CTL stock a sucker’s yield or one of the best dividend opportunities on the market?
CTL Stock Cons
Dividend Cut Risk: For now, CenturyLink’s dividend appears likely to continue at its current rate. Jeff Storey, Level 3’s former CEO and heir apparent at CenturyLink, has declared that the company is “firmly committed to the dividend.” That’s all well and good, but few executives will ever say that they’re not committed to the dividend.
In the longer run, though, CenturyLink may feel there are better uses of cash than paying a 13% dividend. Cut the dividend, and it can either buy back stock at seemingly cheap levels or invest the saved capital in the growing parts of the business. I don’t think the CTL stock dividend is in imminent danger, but don’t count on it continuing indefinitely either.
Collapsing Sector: Legacy telecom companies got hammered in 2017. It continues a longer trend as customers abandon wireline telephones. These companies’ older copper systems have rising maintenance costs and are increasingly under fire from fiber-optic bundles such as Fios from Verizon Communications Inc. (NYSE:VZ).
As a result, two of CenturyLink’s competitors were among 2017’s biggest losers. Windstream Holdings Inc (NYSE:WIN) collapsed from $7.50 to $2. Not to be outdone, Frontier Communications Corporation Corp (NASDAQ:FTR) fell from $50 to just $7 last year.
Windstream already slashed its dividend, and analysts expect an imminent cut from Frontier as well. CenturyLink deserves credit because it picked up an attractive business in Level 3, which should help it avoid the same sorry fate as its peers. Still, you’re going to see pressure on CenturyLink stock if its immediate competitors keep slumping.
Weak Quarter: CenturyLink reported a weak quarter in November. Revenues dropped, and margins slumped for both the consumer and enterprise businesses. Revenues in particular were down 8% year-over-year. The business still hasn’t stabilized, contrary to CTL proponents’ hopes. Now, to be fair, Level 3 reported stronger than expected results and will help balance things out in the future.
On the whole, though, CenturyLink missed expectations, and it also announced that full-year 2017 EBITDA would miss guidance. This is problematic as the company as a massive debtload — more than $20 billion — against a minimal cash position.
The company needs to boost EBITDA to keep creditors at bay. Level 3 should fix these issues, but the merger is of utmost importance now. There’s little room for error.
CTL Stock Pros
Dividend Appears to Be Sustainable: The 13% dividend for CenturyLink stock is the key factor for performance heading into 2018. The bears say a cut is inevitable, either out of necessity or to reorient cash flows into share buybacks, growth or paying down debt.
However, the bulls say the dividend is easily payable out of current profits, and that the company can still buy back stock on top of the current dividend.
And to be fair, they have a point. The company’s payout ratio was around 75% at the time of Level 3 merger (including Level 3’s earnings) and will be heading lower.
Exactly how far remains to be determined, as it depends on how many merger synergies occur with Level 3, and how much the company saves on taxes going forward. Regardless, the company already could cover its dividend, and it will get easier after the merger.
Tax Reform: Things get even better on the dividend sustainability front once you consider the effects of the recently enacted tax reform package. CenturyLink is in the sweet spot as far as benefiting from said package.
The company has been hit with nasty tax rates. This is because the company gushes profits today, and it hasn’t made the sorts of reinvestments that lead to tax deductions. The company’s tax rate over the past year topped 30% and has been as high as the 40% range in recent years. Getting CenturyLink’s effective tax rate into the low 20s will boost the company’s earnings tremendously.
Cheap Stock: Forward estimates for CTL stock put it at just 13x earnings. Just by combining Level 3 and legacy CenturyLink’s results, you get an even cheaper PE ratio if earnings are merely flat on the year. The company trades for near 1x sales and is under book value.
Analysts seem to be warming up to the company post-merger. Morgan Stanley’s analyst hiked the CenturyLink stock price target from $21/share to $26/share. And Barclay’s turned less negative, moving from “Underperform” to “Neutral” in December.
As a consensus, analysts aren’t wildly positive on CenturyLink yet. Then again, by the time they get there, the share price will likely be significantly higher.
CenturyLink Stock Verdict
CTL stock is a high-risk high-reward play. Shares declined more than 30% in 2017, and its sector peers suffered even larger losses. Unlike Frontier and Windstream, however, CenturyLink appears to have a solid plan for the future.
The stock could still plunge again in 2018. Management says the dividend is secure. But a dividend cut wouldn’t be all that shocking. All in all though, I’d suggest that the balance of factors are favorable for CenturyLink stock. Just don’t bet the farm because the stock will likely be volatile. You aren’t getting a 13% yield without some bumps along the way.
At the time of this writing, the author had no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.