Seeking Value in Telecommunications

CenturyLink has a very juicy dividend yield

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Jul 13, 2017
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CenturyLink (CTL, Financial), the $13.48 billion Louisiana-incorporated telecommunications services provider, reported a 4.4% revenue decline year over year to $4.2 billion and an unimpressive 30.9% drop in profits to $163 million in the first quarter, resulting in a 3.9% margin compared to 5.4% in the same period last year.

The drop in profits was evident despite a $57 million (8.3% year-over-year change) drop in operating expenses and a $16 million (5.2%) rise in other expenses.

"CenturyLink's first quarter high-bandwidth data services revenues for Enterprise customers grew by 2% sequentially and 4% year over year, driven by increasing demand for higher-speed Enterprise data services as businesses continue their digital transformation.

"This increasing demand further validates the rationale for our pending acquisition of Level 3 Communications (LVLT, Financial), which will transform CenturyLink into the second-largest domestic communications provider serving global enterprise customers.

"We continue to make good progress in obtaining the necessary approvals for the pending Level 3 acquisition and integration planning for the combination is on track. We are very pleased with the extremely talented and experienced senior leadership team for the combined company announced last week, which will be effective at closing. We continue to expect to complete the transaction by the end of September 2017." – Glen F. Post III, CenturyLink CEO and president

Valuations

CenturyLink is overvalued compared to its peers in terms of earnings multiple with 24.08 times vs. the industry median of 20 times trailing earnings, a price-book (P/B) ratio of 1.01 times vs. the industry median of 2.25 times and a price-sales (P/S) ratio of 0.77 times vs. the industry median of 1.52 times (GuruFocus).

The telecom company had a trailing dividend yield of 8.81% with a 212% payout ratio.

Average 2017 expectations indicated forward multiples of 0.82 times and 11.7 times.

Total returns

CenturyLink failed to outperform the broader Standard & Poor's 500 index in the past five years with -1.53% total returns vs. the index's 15.1% (annualized) returns (Morningstar). The company provided 7.82% total returns vs. the index's 9.13%.

CenturyLink

CenturyLink was founded in 1930 and incorporated under the laws of Louisiana in 1968. According to filings, the company is an integrated communications company engaged primarily in providing an array of services to its residential and business customers.

CenturyLink’s communications services include local and long-distance voice, broadband, Multi-Protocol Label Switching, private line, Ethernet, colocation, hosting (including cloud hosting and managed hosting), data integration, video, network, public access, Voice over Internet Protocol, information technology and other ancillary services.

Based on CenturyLink’s approximately 11.1 million total access lines on Dec. 31, 2016, the company believes it is the third-largest wireline telecommunications company in the U.S.

On Dec. 31, 2016, CenturyLink served approximately 5.9 million broadband subscribers and 325,000 PrismTV subscribers. Further, the company also operated 58 data centers throughout North America, Europe and Asia.

CenturyLink also has a pending acquisition of Level 3 Communications for about $34 billion in cash and stock that was announced in October 2016. It is expected that in January 2019, Level 3 CEO Jeff Storey, 56, will replace 64-year-old CenturyLink CEO Glen Post III. As of its recent quarterly press release, CenturyLink said it remains on track to complete the transaction by the end of September.

The company has two reportable segments: Business and Consumer segments.

Enterprise (formerly Business)

The segment consists generally of providing strategic, legacy and data integration products and services to small, medium and enterprise business, wholesale and governmental customers including other communication providers (1).

The segment’s strategic products and services offered to these customers include Multi-Protocol Label Switching, Ethernet, colocation, hosting (including cloud hosting and managed hosting), broadband, VoIP, information technology and other ancillary services.

CenturyLink’s legacy services offered to these customers primarily include local and long-distance voice including the sale of unbundled network elements, private line switched access and other ancillary services.

The company’s data integration offerings include the sale of telecommunications equipment located on customers' premises and related products and professional services.

In the recent quarter, revenue in the business segment fell 3.5% to $2.36 billion (63% of total unadjusted sales) and delivered an income margin of 44% compared to 46% in the same period last year.

Consumer

Consumer business consists generally of providing strategic and legacy products and services to residential customers. The company’s strategic products and services offered to these customers include broadband, video (including PrismTVservices) and other ancillary services. CenturyLink’s legacy services offered to these customers include local and long-distance voice and other ancillary services.

In the recent quarter, segment revenue fell 5.2% to $1.41 billion (37% of total unadjusted sales) and reported an income margin of 57% compared to 59% the same period last year.

Operational metrics

Access lines

As of March, CenturyLink’s access lines fell by 6% to 10.95 million from the same period last year. According to filings, access lines are lines reaching from the customers' premises to a connection with the public network.

In fiscal years 2014, 2015 and 2016, figures for access lines were 12.39 million, 11.75 million and 11.09 million.

Broadband subscribers

As of March, broadband subscribers fell 2% to 5.95 million compared to March 2016. Broadband subscribers are customers that purchase broadband connection service through their existing telephone lines, stand-alone telephone lines or fiber-optic cables.

In fiscal years 2014, 2015 and 2016, figures for access lines were 6.08 million, 6.05 million and 5.95 million.

Sales and profits

In the past three years, CenturyLink’s revenue declined by an average of 1.16% and recorded a profit margin average of 4.3% (Morningstar).

Cash, debt and book value

As of March, CenturyLink had $214 million in cash and cash equivalents and $19.7 billion in debt with a debt-equity ratio of 1.48 times vs. 1.43 times in the same period last year. The company recorded $346 million in debt year over year while shareholder equity also declined by $730 million.

Of CenturyLink's $46.6 billion assets 51% were identified as goodwill and intangibles. The company registered a 5.2% year-over-year decline in book value to $13.3 billion.

Cash flow

In the first quarter, CenturyLink registered 25.7% decline year over year in its cash flow from operations to $1.06 billion. In addition to lower profits, the company also registered higher cash outflow in relation to its deferred income taxes, accounts payable and other current assets and liabilities, net.

Capital expenditures were $780 million leaving CenturyLink with $277 million in free cash flow compared to $812 million in the same period last year. CenturyLink allocated 106.86% of its free cash flow in shareholder dividends.

On average, CenturyLink allocated 83% of its free cash flow in dividends and share buybacks in the past three fiscal years.

In the recent quarter, total shareholder count rose by 2.76 million year over year. The company also allocated about $26 million in debt repayments net any issuances.

Conclusion

CenturyLink exhibited declining revenue growth year over year as of the recent quarter. Nonetheless, the company’s pending acquisition of Level 3 may help this declining business growth turn around. Level 3, despite its $10.9 billion long-term debt, had a three-year average revenue growth of 8.98% (Morningstar).

The company carried a leveraged balance sheet with more than half of its assets goodwill and intangible assets. Further, CenturyLink was able to provide what seems to be a fair level of free cash flow payouts to its shareholders in recent years.

Fifteen analysts have an average price target of $26.2 per share –Â 8.4% higher than the share price of $24.18 (at the time of writing). Applying a three-year P/S multiple and revenue growth averages followed by a 20% margin indicated a value of $23.5 per share.

In summary, Century Link is a hold.

Disclosure: I do not have shares in the company mentioned.