EUR 850.00 For Business Accounts Only

Morningstar | CenturyLink's Dividend Cut Masks the Firm's 2018 Operating Execution; Maintaining $22 FVE

In conjunction with its fourth-quarter earnings release, Century Link announced it will cut its annual dividend to $1 per share, down from $2.16. Given that management constantly implied support for its outsize dividend in the past, the news overshadowed CenturyLink's performance, which we found encouraging. We believe CenturyLink's businesses lack a moat and have long-term deflationary pricing trends, so we project virtually no sales growth over our five-year forecast. However, management is hitting its synergy targets following the 2017 Level 3 acquisition and showing an ability to grow EBITDA, despite continuing revenue weakness. With the firm's 2019 guidance in line with our projections, we expect no major change to our $22 fair value estimate.

Although the dividend cut may be painful for shareholders in the near term, due both to the stock's negative reaction to the news and reduced dividend income, we strongly believe the move is good news for long-term shareholders, and we applaud management for making the move, although they probably could have foreshadowed it in a better way. We had been forecasting a 50% dividend cut in 2020 (given management's stated commitment to it, we thought they would hold out on a cut until sizable debt maturities hit in 2020), but we expressed our view that continuing to pay it was not the wisest capital allocation decision. With CenturyLink now planning to reduce its leverage ratio to around three times EBITDA over the next few years (down from the four to five range the last couple years), we expect more flexibility to take advantage of business opportunities and fewer solvency concerns if market conditions weaken. We're more comfortable with CenturyLink's financial position because of the news.

Somewhat lost in the dividend conversation was that management said it realized all planned Level 3 synergies ($850 million-worth) by the end of 2018, two years sooner than it had publicly projected, and that it was now expecting to realize additional synergies from the merger. Results backed up the rhetoric, as the 2018 adjusted EBITDA margin expanded 250 basis points from 2017's pro forma 34.2% margin, while the fourth-quarter margin was up almost five percentage points from 2017's pro forma fourth quarter. If management realizes the new synergies it now identifies, the 150 basis points of additional margin expansion we forecast in total over the next five years might be conservative.

However, even though management may find further cost savings, revenue remains a sore spot. Pro forma revenue declined 4% year over year in the fourth quarter and 3% for the full year, with business revenue down 2% (in both the quarter and full year) and consumer revenue down 8% in the quarter and 6% for the year. We forecast slight improvements from these levels over time—a return to growth (less than 1%) in the business segment and continued contraction, though improved, in the consumer segment—but we think the business remains extremely challenged as newer technologies depress pricing for business customers and consumer voice services are trending toward extinction. Still, we think growing demand for data traffic on the business side and a shift to improved broadband speeds on the consumer side will ultimately lead to a modest improvement.