So we're comfortable with the payout ratio. So if you look at our payout ratio this year, it was in the mid-50s, and we did have some one-time benefits this year from lower capital spending from tax refunds. We do not make a $ 500 million contribution to the pension fund . So if you look at all that and normalize our payout ratios, we're in the low 70s; any reasonable expectations for us for the next few years you still see very good dividend coverage. So we're comfortable with the payout ratio. – Neel Dev, CFO ( Dec 4, 2018 )
In summary, I feel good about the market opportunity and the progress we're making in serving our customers. You will see us continue to focus on selling profitable services to our customers, carefully managing our expenses and expanding our margins. We remain committed to and confident in our ability to maintain the dividend. ̵1; Jeff Storey, CEO ( May 9, 2018 )
The CenturyLink (NYSE: CTL) dividend cut is one that will likely rock the high-yield equity investment world. It's tough out in high yield, and I think many shareholders had backed themselves into a corner thinking the payout was untouchable because of the guidance. These investors are going to be very angry and quite upset. Management is about to get a hard lesson in just how destructive the loss of shareholder goodwill can be, and investors are also going to learn a lesson on why management statements on dividend health should not be taken at face value. Wall Street analysts, long-dated by retail investors for their calls that the dividend would be cut, have been proven right. Given this is a large-cap bombshell that will touch more investors than most, my hope is that this will foster more independent thought and research among smaller shareholders.
coals. David Barden from Bank of America already did an excellent job on the Q4 conference call for many of the same reasons that I am about to. In my opinion, this was a misinformed decision that is going to cause the stock price to be long for quite a long time. Also, the exit of Aranda Investments, which liquidated the whole of its 16mm share investment in January, also looks suspiciously present today.
Management Reasons On Why It Cut
On the Q4 2018 conference call, Jeff Storey stated that the dividend cut was prompted by "our view that the long-term interest of shareholders by proactively accelerating delegation of the balance sheet". In its view, it would be improved, due to this move and equity holders would see benefit. This could not be further from the case
Number one, nothing has changed from when Jeff Storey took over as CEO last year to today. The business is executed decently well – if anything it has performed better than expected – and the fundamental outlook has not changed. Despite the lamentations of management, if this was the right capital allocation plan, then it should have been enacted when fresh leadership took over the helmet. It should not be nearly a year down the line after management had swore up and down that it was comfortable with the payout ratio.
Excuse me, what? CenturyLink's near-term maturity bonds today, such as the 7.5% due due 2024 (CUSIP 156700BA3), already trade at par. Immediate term credit trades are even cheaper. Investors have to go way, out on the maturity ladder to long-dated maturities like the 7.6% bonds due 2039 to find bonds that trade below par (those at 9.3% yield to maturity (CUSIP 156700AM8)). Even in those cases, those discounts will likely close tomorrow as bondholders, long before management ever has a chance to get a dime towards retiring them early. The weighted average cash interest rate paid across the business is just 5.8% today, which is not terribly far from the level of peers. 6-7% return on cash alongside no pressing need for refinancing is not a reason to proverbially shove shareholders out of a moving car on a freeway.
While the company does carry a junk bond rating, achieving investment grade, and its new 3x leverage target probably doesn't get it there. Management stated directly on the call that its 3x leverage target had nothing to do with a rating agency metric to achieving investment grade
The maturity ladder at CenturyLink was light; There is little in the way of near-term maturities that had to be rolled out. The company had years to work down its leverage. Cutting today and retiring debt trading is just about the worst use of capital I've seen. Meanwhile, management did very little to know (or sell-side analysts) that the excess savings from retained cash would help grow EBITDA in a meaningful matter.
Scenario Models, Takeaway
Literally everyone that has bought the stock over the past four to five months did so for the dividend. That was done in large part because of management's statements and scenario modeling. I ran a few of these scenarios late last week based on the old dividend: Source: Author calculations
- 5% annual revenue declines from 2019 levels, and acceleration from current levels. ] EBITDA margin relatively flat; revenue declines offset by unwinding of operating leverage. These margin levels are roughly in line with the Q3 2018 results.
- Mild cash interest expense declines as debt paydown reduces interest expense than the impact of rising financing cost. Current all-in interest expense is roughly 5.8% on a weighted basis; my 2022 case is the same.
- Higher costs on refinancing rolls would be the outlook. Relatively flat cash taxes versus 2018 levels
* Source: Author calculations
- 3% annual revenue declines, broadly in line with current decline rates
- EBITDA margin continues to inch higher than unproductive business lines are eliminated; synergies continue. Management has spoken of this business as a "high 30s, 40%" EBITDA margin capable asset base.
- Stronger declines in cash interest expense as free cash flow is dedicated to debt paydown; continue to view 5.8% as the ongoing weighted average interest rate
- Incrementally, but not materially, higher cash tax expense.
If you take the Q4 2018 conference call at face value, the company is actually forecasting EBITDA growth over the next several years in order to get to its new 2.75-3.25x leverage target. That means that even my base case above was slightly bearish especially if very little in the way of upsized capital spending is implied in management's models.
It pains me deeply when management can take a great business with a great runway to growth and shoot itself in the foot. That's what CenturyLink has done here. I think the asset base here is great, but management has obliterated the catalysts it had for a higher share price. In my view all needed to send shares back above $ 20 / share and close the intrinsic value gap it has claimed about is to do two things:
- Affirm 2019 EBITDA guidance at around 2018 levels
- Hit that guidance
- Pay the existing dividend
Three simple things. Management will have proven itself, it would have put business positioning into bed as revenue declines moderated and it would have protected equity holders.
I often write about these cuts from the position of an outsider. Not this time. As a (very) recent long, I'll be sharing in the pain today. However, I was cognizant of risks. Here is the tail of the note I sent out to my members in February:
This is going to be a dividend story; if it gets cut there will not be much of a floor despite the embedded value in the business. There is quite a lot of yield chasing going on here, especially given how firm CEO Jeff Storey and new CFO Neel Dev have been on its safety. If they are going to cut, Q4 is when they are going to do it ahead of the 2019 outlook. For those who are risk averse, stay away until after the dust settles.
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Disclosure: I am / we are long CTL I wrote this for [ NO OBLIGATION FREE TRIAL today. article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.