Published by Bob Ciura on April 7th, 2017
Double-digit dividend yields are enticing, but can often be a trap.
A sky-high dividend yield can be like a mirage. It looks great from a distance, but can disappear once reality sets in.
This seems to be the case with Frontier Communications (FTR).
Frontier currently has a 20% dividend yield.
Even in the telecommunications sector, which is typically a high-yielding industry as it is, Frontier blows its peer group out of the water.
Consider that AT&T (T) has a 4.7% dividend yield, which looks relatively puny by comparison.
AT&T is a Dividend Aristocrat, a group of companies in the S&P 500 that have raised dividends for 25+ years.
While both are high dividend stocks, the trade-off is that AT&T’s lower dividend yield is far more secure than Frontier’s.
A dividend stock is only as good as the sustainability of its payout, which is why investors should resist the urge to buy Frontier, and stick with AT&T instead.
Frontier is in a very difficult position. Conditions are deteriorating in its core operations, and Frontier has lost money in each of the past two years.
The company has responded by acquiring new customers.
For example, last year Frontier closed on its $10.5 billion acquisition of 6.6 million new connections from Verizon Communications (VZ) half of which were voice customers, in California, Texas, and Florida (CTF).
The problem with the deal, was that Frontier paid huge amounts of money for wireline assets, which are rapidly becoming obsolete.
Making matters worse, Frontier quickly ran into a problem of unpaid bills.
Source: 4Q Earnings Presentation, page 5
Unpaid bills cost Frontier $45 million of lost revenue in the fourth quarter alone.
Frontier’s average monthly revenue per customer fell to $80.33 last quarter, from $82.34 in the previous quarter.
In 2015 and 2016, the company posted losses of $0.29 per share and $0.51 per share, respectively.
By comparison, AT&T is highly profitable, and is growing earnings-per-share.
It had net income of $13.3 billion last year alone.
Source: 4Q Earnings presentation, page 6
AT&T generated adjusted earnings-per-share of $2.84 in 2016, up 4.8% from the previous year.
Revenue increased 12% for the year, driven by a full year of growth from DIRECTV, and growth in IP services and video.
AT&T’s operating cash flow hit a record last year, and there is potential for further growth up ahead.
Frontier’s account cleanup process will remain a headwind in 2017. The company expects $25 million in lost revenue for the first quarter.
Even when it resolves its CTF customer issues, there will still be continued problems with its legacy business.
Revenue from Frontier’s legacy operations declined 5.4% in 2016, driven by an 11% drop in voice revenue. Operating expenses in the legacy business rose 2.8% for the year.
Source: 4Q Earnings Presentation, page 8
Due to Frontier’s outdated technology services, it is losing customers.
Churn stood at 2.08% in the fourth quarter, up from 1.76% in the fourth quarter of 2015.
For its part, AT&T had postpaid phone churn of 0.98% and wireless postpaid churn of 1.16% in the fourth quarter.
Losing customers, elevated costs, and lost revenue from unpaid bills, will all drag on Frontier’s growth in 2017 and beyond.
AT&T, meanwhile, has an outlook of growth, thanks to its huge acquisitions and pending deals in the pipeline.
Source: Time Warner Acquisition Presentation, page 6
Its most recent deal is the pending $109 billion acquisition of Time Warner (TWX).
Time Warner owns cable networks including TNT, TBS, and CNN, and the premium networks HBO and Cinemax. Time Warner also has the Warner Bros. movie studio.
The combination would create a global giant, with 144 million worldwide mobile customers, and another 45 million video customers.
Excluding the Time Warner deal, which has not closed yet, AT&T expects to generate low-to-mid single digit revenue growth, and mid-single digit earnings growth in 2017.
If the deal goes through, AT&T’s growth rates could be even stronger.
Frontier recently paid a quarterly dividend of $.105 per share, unchanged from the previous level. On an annualized basis, Frontier’s dividend is $0.42 per share.
Based on its April 4 closing price of $2.13 per share, Frontier’s dividend yield sits at 20%.
Such a whopping dividend yield is appealing on the surface. After all, who wouldn’t want to earn a 20% return from dividends each year?
But when it comes to investing, if a dividend yield looks too good to be true, it usually is just that.
Frontier has already cut its dividend twice since 2010.
And, Frontier’s balance sheet is loaded with debt.
Due in large part to the Verizon deal, Frontier is saddled with $17.5 billion of long-term debt, with just $522 million in cash.
Its deteriorating balance sheet is reflected in its credit ratings.
Frontier has a credit rating of B+ from Standard & Poor’s, which is firmly in junk territory. The company receives a negative outlook from all three major credit rating services.
Adding to the problem is that Frontier’s free cash flow fell well below its dividend payments last year.
For 2016, Frontier generated $270 million of free cash flow. Its dividend required $707 million in cash.
AT&T’s dividend is secured with free cash flow. It generated $16.9 billion of free cash flow in 2016, up 6.8% year over year.
This easily covered its dividend, which required $11.8 billion of cash.
On the company’s fourth-quarter conference call with analysts, Frontier’s CEO stated that the company would “continue to evaluate” the dividend moving forward.
Investors should be less-than-assured by management’s comments. As much as the company might want to maintain its hefty payout, the fundamentals say otherwise.
A 20% dividend yield can be a trap, and Frontier stock seems to be just that. Unless Frontier’s financial health significantly improves, which seems unlikely, investors should not be surprised if the dividend is cut or suspended at some point in 2017.
At the heart of Frontier’s problems is that it shelled out more than $10 billion to acquire lots of customers in declining areas of telecommunications, such as landline phones.
Its legacy portfolio is in a similar position, and is seeing customer losses and falling revenue per customer.
AT&T has a much lower yield than Frontier, but it still has a solid 4.7% yield, which is more than double the average yield in the S&P 500.
And, AT&T has raised its dividend for 33 consecutive years. In this instance, investors would be much better served buying AT&T.
To see why AT&T is also a better investment right now than its biggest competitor, Verizon, click here.