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Frontier - A Dividend Cutter to Avoid

March 07, 2012 | About:
Frontier Communications Company (FTR) is in a tremendously competitive industry. At first glance, the company would seem to be one to avoid. Its share price has recently fallen and its dividends were cut. At the same time, to support these dividends, it has had to reach beyond what it earns, resulting in an enormous payout ratio. In this article, I will elaborate on some of these concerns and ultimately come to a conclusion on what to expect this year in regards to the dividend payment.

Competitive Position

Frontier provides unregulated and regulated voice, data, and video services in the United States to residential, business, and wholesale customers. Main competitors are AT&T Inc. (T) and CenturyLink Inc. (CTL). AT&T has a trailing annual dividend yield of 5.8%, amounting to a $1.73 payment that is sustained with a 261% payout ratio. It has a forward rate of $1.76. CenturyLink has a trailing yield of 7.6%, which is well above the five-year average of 5.1%. This 7.6% yield amounts to an annualized dividend of $2.90. This is maintained with a payout ratio of 158%.

Dividend History

Frontier did not offer a dividend until 2004 when it paid $0.50 per share. The following year, it doubled its dividend to $1.00, which is where it remained through 2009. In 2010, its dividend declined to $0.88 and as of the most recent trailing twelve months (TTM), the dividend amounted to $0.75. This 18.2% yield is on the lesser end of the 9.4% fiver-year average. Not to be misled. The reason for the decreasing rate with a concurrently increasing yield is the gradual decline in share price. Frontier is currently paying a $0.75 annualized dividend with a 500% payout ratio.

Profitability

A 500% payout ratio implies insufficient earnings to cover dividend expenses. From 2006 until 2009, net income steadily declined. The 2009 net income was 55.6% less than the 2006 net income. However, the net income has since increased by over 26% into 2010. However, EPS has been diminishing even further due to an increased number of shares outstanding. Shares outstanding increased by 110% from 2009 into 2010 and by another 47% into the TTM.

For the most part, the gross, operating, and net margin have been declining on an annual basis from 2006. In total, the gross, operating, and net margin have fallen by 4%, 46.2%, and 83.6%, respectively, from 2006 into the TTM. Shrinking margins in a company that is already having trouble growing earnings suggests the potential for further dividend cuts.

From 2009 into 2010, Frontier’s total assets increased by 160%. This was a result of the acquisition of Verizon’s (VZ) local exchange business and related landline activities in several states in July of 2010. From 2009 into the TTM, revenue subsequently increased by about 151%. Ideally, revenue would have increased by a greater amount. However, the acquisition may have contributed more to its growth potential and a further incline in revenue has yet to come.

Cash Flow

Despite other deficiencies, the operating cash flow and free cash flow have subsequently increased in the last few years. In fact, since 2008, operating cash flow and free cash flow appreciated by 117% and 47%, respectively. The contribution to cash was largely due to a correspondingly large increase in depreciation and amortization, resulting from the acquisition. Another large portion of the increase in the operational cash flows was the increase in deferred taxes. It would be more beneficial for a higher portion of the cash increase to be attributable to net income.

The actual cash balance listed on the balance sheet fell by about 30% from 2010 while working capital was -$311 million in 2010, down from $287 million the prior year. Although the statement of cash flows looks healthy at first glance, sources of cash are unsatisfactory.

Projection

Frontier has exponentially increased its shares outstanding, resulting from the acquisition. Although it decreased its dividend payment, the total dividend expense has been rising due to dilution. The slight increase in net income is not substantial enough to sustain a growing dividend. If the dividend doesn’t remain at its current levels, I would expect a marginal decline in the payment. The acquisition has not brought the revenue growth that the company likely expected and that investors are relying on. Also, because of increased costs, the growth in revenue has translated into almost no growth in earnings. Frontier would not be wise to announce any increase its dividend payment this year.

About the author:

Dividend King
I am primarily an investor interested in creating passive income streams through dividends. I focus on finding and analyzing dividend paying stocks, MLPs and REITs that are a good fit for income investors.

I practice Judaism and my faith is very important to me. I visit family in Israel once a year, but I am educated and work in the United States where I hold an MBA and a bachelor’s in English. I am a patient man, enjoy wine but am not a connoisseur, and I listen more than I speak.

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