Better Buy: CenturyLink Inc. vs. Frontier Communications

The quest for chunky dividends has sent income investors scurrying into independent local exchange carriers in the past, but it’s a whole new ballgame in the telecom space these days. Frontier Communications (NASDAQ: FTR) — which at one point earlier this year was packing a yield north of 36% — suspended its payout in February. CenturyLink (NYSE: CTL) is still shelling out a fat dividend that yields nearly 12%, but it has been making needle-moving acquisitions to diversify its business.

The narratives are changing. Frontier Communications is now a turnaround play, but a risky one. CenturyLink, after years of lagging the market, is actually beating it in 2018. The two seem to be passing ships, but Frontier isn’t as bad as its stock chart may suggest, while CenturyLink still has a lot to prove.

Image source: CenturyLink.

Making the call

Frontier isn’t at its best right now. It has strung together 13 consecutive quarterly deficits. Revenue has declined for four straight quarters, and before that, all of its growth came from the Verizon landline assets it paid $10.5 billion for two years ago. Organic revenue is falling across all of Frontier’s businesses, and plans to sell assets so it can pay down its debt have been stymied by a dearth of potential buyers.

The suspension of Frontier’s quarterly dividends should not have surprised anyone. The payouts weren’t sustainable, and the struggling telco had already slashed its rate three times in recent years. When life gives you a 36% yield, investors, look it in the mouth. Spot the fiscal gingivitis.

Some stocks actually rebound after eliminating their dividends, but only if investors feel that diverting the funds toward more pressing obligations will give the company a chance to turn its operations around. Wall Street isn’t betting on such a renaissance at Frontier. One analyst who downgraded the stock after Frontier nixed its distributions argued that there’s no longer a thesis for owning the stock.

CenturyLink is holding up considerably better, and its new CEO is committed to maintaining its healthy dividend, even if its payout ratio has been above 100% every year since 2010. The company has tried to take advantage of the telecom sector’s consolidation trend, snapping up Embarq, Qwest, and Tier3 over the years. It closed on its biggest purchase late last year when it acquired Level 3 Communications in a $25 billion deal. The transaction helped expand CenturyLink’s push into broadband and corporate accounts. Perhaps more importantly, the purchase brought it new leadership, as Level 3’s former helmsman Jeff Storey is now CEO at CenturyLink.

Both Frontier and CenturyLink have identified cost savings that they could realize as a result of their big-ticket acquisitions, but only CenturyLink is currently profitable. Frontier faces an uphill battle to reach that status.

Between the two, CenturyLink is clearly the better choice for investors today, but it’s not without its risks. Macquarie analyst Amy Young downgraded its stock last month, concerned about secular headwinds and a stock valuation that she feels has already priced in the speculative upsides of Storey’s management and upcoming synergies. It has a long way to go before it earns this year’s share price gains. But Frontier’s bondholders are reportedly getting restless — that stock’s just not suitable for investors other than those comfortable with taking on a lot of risk as they swing for the fences.

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Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool owns shares of Verizon Communications. The Motley Fool has a disclosure policy.

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