We last looked at CenturyLink’s (NYSE: CTL) dividend safety in June 2015. It was rated a D due to falling cash flow and a recent dividend cut.
Today, I’m looking at the stock with a new perspective.[ad#Google Adsense 336×280-IA]In October, the company said it would acquire Level 3 Communications (NYSE: LVLT) for $34 billion. The deal, which is expected to close in the third quarter of next year, is a game changer for the company.
CenturyLink traditionally operates telecommunications in rural areas. The merger with Level 3 places its wires in urban areas, including 65,000 buildings.
CenturyLink should generate a lot more cash flow when combined with Level 3’s cash flow.
Additionally, CenturyLink’s management estimates the combined companies will save $975 million in costs.
However, in order to fund the merger, the company will have to add to its already heavy debt load – in a rising interest rate environment. It will also issue more shares of stock, which will add to the amount of dividends paid.
In the press release announcing the deal, CenturyLink’s management said, “Improved free cash flow will enhance the combined company’s financial flexibility and significantly lower its payout ratio. CenturyLink expects to maintain its annual dividend of $2.16 per share.”
Let’s take a look and see if that’s viable…
Another $413 Million
At the end of the third quarter, CenturyLink had $140 million in cash and $19.7 billion in debt. Its interest expense in the first nine months of the year was $998 million.
But as I mentioned earlier, in order to complete the deal, CenturyLink will have to take on $11 billion in new debt.
Currently, its bonds are rated Ba2 by Moody’s and BB by Standard & Poor’s. The average yield on 10-year Ba2-rated bonds is around 3.75% to 4%.
Let’s be generous and assume CenturyLink can issue $11 billion of debt at 3.75%. That will add another $413 million in interest the company has to pay each year.
And that number could go higher if rates continue to rise before CenturyLink issues the debt.
Additionally, the company will have to issue more than 500 million shares as part of the deal. And that’ll add more than $1 billion in annual dividend payments if, indeed, it keeps its dividend intact.
Even though management expects the deal with Level 3 to add to cash flow, Wall Street analysts aren’t as optimistic…
They expect free cash flow to decline next year to $1.5 billion from $1.8 billion. Dividends paid are projected to be $1.2 billion, putting the payout ratio above my 75% safety threshold.
After 2017, we could see an increase in cash flow, but that added pressure from the higher debt load and the near doubling of the share count makes the dividend unsafe.
The fact that CenturyLink already cut its dividend in 2013 also makes me think another one is coming.
If the dividend is lowered, it wouldn’t be the first time a management team said its dividend would be maintained, but then cut it shortly after.
I believe management is being too optimistic.
Dividend Safety Rating: F
Source: Wealthy Retirement