Is CenturyLink, Inc. (NYSE:CTL) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
A high yield and a long history of paying dividends is an appealing combination for CenturyLink. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Although it reported a loss over the past 12 months, CenturyLink currently pays a dividend. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.
The company paid out 51% of its free cash flow, which is not bad per se, but does start to limit the amount of cash CenturyLink has available to meet other needs.
Is CenturyLink’s Balance Sheet Risky?
Given CenturyLink is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. CenturyLink is carrying net debt of 3.71 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 2.01 times its interest expense, CenturyLink’s interest cover is starting to look a bit thin.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. CenturyLink has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was US$2.80 in 2009, compared to US$1.00 last year. This works out to be a decline of approximately 9.8% per year over that time. CenturyLink’s dividend has been cut sharply at least once, so it hasn’t fallen by 9.8% every year, but this is a decent approximation of the long term change.
When a company’s per-share dividend falls we question if this reflects poorly on either external business conditions, or the company’s capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it’s even more important to see if EPS are growing. CenturyLink’s earnings per share have shrunk at 44% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and CenturyLink’s earnings per share, which support the dividend, have been anything but stable.
To summarise, shareholders should always check that CenturyLink’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We’re a bit uncomfortable with the company paying a dividend while being loss-making, although at least the dividend was covered by free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. There are a few too many issues for us to get comfortable with CenturyLink from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
Given that earnings are not growing, the dividend does not look nearly so attractive. See if the 13 analysts are forecasting a turnaround in our free collection of analyst estimates here.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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