Shares of internet service provider CenturyLink (NYSE: CTL) are plumbing fresh lows after reporting a solid conclusion to 2018 and slow but steadily improving profitability. The real news, though, was the surprising -- but also not-so-surprising -- announcement that the annual dividend is being cut from $2.16 per share to $1.00 per share. While the previous yield was a ridiculous 14%, management had indicated it was on solid footing. The new yield is still a generous 7.7% as of this writing, and CenturyLink has new plans for that cash going forward. Is the new payday amount sustainable? The short answer is yes, but there are question marks surrounding the why.
First, a review of 2018
After CenturyLink's takeover of Level 3 Communications in 2017, investors may have been hoping for better sales results. That didn't transpire this year as the telecom's legacy services continue to slide. The good news, though, is that the company completed its cost-cutting initiatives post-Level 3 merger a couple of years ahead of schedule, providing a big boost to free cash flow (money left over after basic operations and capital expenditures are paid for).
| Metric | Full-Year 2018 | Adjusted Full-Year 2017* | Change (YOY) |
|---|---|---|---|
| Revenue | $23.44 billion | $24.13 billion | (3%) |
| Cost of services and products | $10.86 billion | $11.50 billion | (6%) |
| SG&A expenses | $4.17 billion | $4.72 billion | (12%) |
| Capital expenditures | $3.18 billion | $4.23 billion | (25%) |
| Free cash flow | $3.86 billion | $1.57 billion | 146% |
| Total dividends paid | $2.31 billion | $1.45 billion | 59% |
Data source: CenturyLink. *Adjustments to account for the Level 3 acquisition. YOY = year over year.
Because of the aggressive cost-cutting associated with the integration of Level 3, CenturyLink's tenuous-looking dividend actually seemed like a safe bet -- even though total dividends paid out ballooned because of the extra shares CenturyLink issued to help pay for the acquisition. The dividend payout ate up about 60% of free cash flow last year.
Management said it expects free cash flow to drop to between $3.1 billion to $3.4 billion in 2019, in large part due to increased capital expenditures (purchase of property and equipment) of $3.5 to $3.8 billion -- thus the surprise from some investors that the payout got a haircut, as the $2.16 per share a year would have put dividends paid at roughly $2.3 billion in total: still well within the free-cash-flow guidance. With the payday dropping to just $1.00 a share and $1.08 billion in total consideration, the payout ratio to cash flow will be around 30%. Long story short, the new dividend yield is easily sustainable assuming nothing drastically deviates from CenturyLink's expectations.