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Why Investors Should Avoid CenturyLink for Now

Chris Lau

When CenturyLink (NYSE: CTL) slashed its dividends in February 2019, investors hurried for the exits. Even at the stock’s new $1 dividend rate, less than half what it used to be, the yield is still 8.4%. The problem now is that markets lack confidence for management and risks are high that the company may cut its dividend rate further.

Is CenturyLink Stock a Treasure or Trap? 3 Pros, 3 Cons

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Investors need to evaluate how risky CenturyLink’s business is and if the currently generous yield is worth chasing.

Strong Cash Flow for CTL Stock

CenturyLink reported adjusted EBITDA of $9.04 billion. Adjusted EBITDA margin topped 39.8%, while cash flow was $4.215 billion. This is more than double the $2.03 billion in FCF reported last year. Investors should note that the FCF is more than enough to cover the dividend but management opted to revise its capital allocation plan. The company may have two big reasons to cut the dividend.

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First, all of the business units within CenturyLink reported falling year-on-year revenue declines. Overall, the business revenue declined 2.2% from last year to $4.32 billion. On the consumer side, revenue fell 6.5% to $1.285 billion. Its consumer broadband subscriber count was 4.8 million in Q4/2018. The weak performance is troubling because it suggests the company is in a mature business phase. Without at least some growth, investors are hard-pressed to find reasons to buy the stock and expect the share price to hold its value.

Second, the company said it would use the savings to create value through acquisitions. It said:

“A stronger balance sheet in the out years will also give us more optionality in terms of additional organic and/or inorganic investments. We believe we have a good track record of creating value with acquisitions.”

The savings from the dividend cut will help CenturyLink achieve a better leverage ratio. Although it will not rush out to complete any acquisitions in the near-term, the three-year plan includes improving the health of the balance sheet. This would enable it to make acquisitions without hurting investors or its balance sheet.

Financial Targets for Centurylink

Management is determined to accelerate its deleveraging over the next three years. Net debt to adjusted EBITDA is unfavorably high, falling from 4.3 times in Q4 2017 to 4 times in Q4 2018. It has a goal of narrowing and lowering its leverage range to 2.75 times-3.25 times.

For 2019, CenturyLink forecasts FCF in the range of $3.1 billion to $3.4 billion. Adjusted EBITDA will be in the range of $9 billion to $9.2 billion. With these strong numbers ahead, the company could increase its capital investments by around $500 million. Still, if business revenue fell last quarter, aggressive infrastructure investments may not spur higher demand. In this scenario, the company will end up spending more but getting little return from its investments.

Selling Pressure

The ongoing downtrend in the stock in the last few years is another headwind for those who want to sell the stock in the hopes of breaking even. Other investors who paid a higher share price may sell into any rally. And any wave of selling will continue unless the company demonstrates that the business is firming up.

The Takeaway

CenturyLink has a solid product and great assets. Customers demand more capacity at more locations and need more product variety. This includes Dark Fiber, SD-WAN, and things in the middle. So if the company can sell these customers solutions that transition them off legacy services, CenturyLink has an opportunity to improve overall revenue.

CenturyLink’s debt reduction priority and dividend cut angered investors and will put a cap on the stock’s rebound potential. And because the stock is likely to underperform for a while, investors should not buy in just yet.

Despite that, CTL stock is worth watching. If management can speed up its deleveraging and win more business from customers, the stock has a chance of rebounding in the longer-term.

As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.

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