The Safety Net: Expect Another Cut to This 7.8% Yield
One of the strongest indicators that a company could cut its dividend is that it’s done so in the past. Once a company has made that decision once, it’s easier to do it again. And again.
I suspect that’s going to be the case for Frontier Communications (Nasdaq: FTR).
The company provides telephone and broadband Internet services to more than 3 million residential customers and nearly 300,000 business clients.
I last covered Frontier two years ago and gave it a “C” rating. At that time, free cash flow comfortably covered the dividend, though I was concerned that it would decline, which it did. (More about that in a moment.)
My other real issue was that the company had a track record of cutting its dividend. Since it started paying a $0.25 per share quarterly dividend in 2004, the dividend has been reduced twice – first to $0.1875 per share in 2010 and then to $0.10 in 2012.
Last year, the company raised the dividend quarterly by half a cent…
But I suspect the dividend is headed back in the other direction.
At $0.105 per quarter (or $0.42 per year), the dividend Frontier currently pays offers a healthy 7.8% yield.
Now, back to that cash flow issue.
In 2013, free cash flow was $861 million while Frontier paid out $400 million in dividends for a payout ratio of just 46%. That’s enough of a cushion for it to pay and even raise the dividend.
In 2014, free cash flow declined to $582 million while the company paid out $401 million in dividends. The 69% payout ratio was still within my comfort zone.
However, 2015’s numbers were not good.
Free cash flow was just $438 million while the company paid dividends amounting to $576 million. So free cash flow did not cover the dividend. That’s a problem.
This year, Frontier is expected to generate enough free cash flow to pay the dividend, but the payout ratio is forecast to be above my comfort level of 75%.
So we’ve got a company with negative free cash flow growth the past two years, a payout ratio that is too high and two recent dividend cuts.
It’s possible that at the end of this year, if Frontier’s free cash flow is higher than expected, the stock will get an upgrade. But for now the dividend has to be considered at risk.
Dividend Safety Rating: F
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