Lumen's Substantial Fiber Investment Plans Keep Pressure on Dividend
Lumen's stock has slumped more than 20% since reporting earnings on February 9, pushing its dividend yield north of 10%.
Formerly known as CenturyLink, the telecom provider issued disappointing 2022 guidance, which caused some investors to worry about Lumen's plan to ramp spending on fiber delivered to consumers and small businesses.
Management's big bet on fiber internet service is intended to return the company to sales growth within several years. But the infrastructure required to reach millions of additional households requires substantial investment.
The current deployment plan calls for $1 billion of spending on fiber in 2022 alone, an amount equal to about 10% of Lumen's market cap. Fiber investment is set to increase in 2023, too.
Based on Lumen's latest guidance, the firm's free cash flow payout ratio will likely rise from about 30% in 2021 to nearly 100% in the second half of 2022 and 2023 as capital spending ramps.
Despite anticipating a very high payout ratio, Lumen's dividend has some cushion provided by the $7 billion of proceeds the firm will receive from two divestitures closing later this year.
For context, the dividend costs about $1 billion per year, and annual capital expenditures will likely run between $3 billion and $4 billion the next couple of years.
Management hopes to execute its fiber growth plan while keeping Lumen's BB rated balance sheet relatively leverage-neutral and maintaining the firm's $1.00 per share annual dividend.
As capital spending eventually recedes and fiber revenues ramp, management expects dividend coverage to return to a more sustainable level:
"As we look at the dividend and the payout ratio, and I've said this before, we think that the dividend is an important part of our shareholder value proposition. We think the $1 per share is attractive to investors and it's sustainable, so we're very comfortable with the dividend there.
"I've also said that in 2022 and the next few years, we are going to be investing in growth. And you mentioned Quantum Fiber, and with the Quantum Fiber build, we think that, that should be viewed as a discrete project that starts already and ends in a few years as we complete the 12 million enablements that we expect over the coming years. We also expect to return to top line revenue growth.
"While we do see the payout ratio rising in the near term, with those two things, we think that it will return to more normal levels over time."
– CEO Jeff Storey
Regardless, the margin of safety looks slim, and management's dismal capital allocation track record inspires little confidence that these major investments will finally turn the business around.
For example, Lumen has made more than $60 billion in acquisitions since 2008, including the $34 billion Level 3 merger in 2017. Yet all this spending has failed to restore the business to top or bottom line growth, or prevent two dividend cuts totaling over 75%.
Source: Simply Safe Dividends
The success of Lumen's fiber deployment plan hinges on the firm's ability to get households and small businesses to pick its faster, more reliable internet service over alternative options.
Some analysts believe Lumen needs to penetrate at least 40% of its addressable households to earn a solid return on its fiber investments, higher than the company's 29% penetration rate across its existing fiber footprint. Getting there could require major marketing investments.
Even if fiber penetration rates increase in the years ahead, the rest of Lumen's business has struggled to grow as technology improvements and stiff competition put constant pricing pressure on network infrastructure and services.
A lot of these concerns are reflected in Lumen's depressed valuation, and there are worse 10%-yielding stocks out there for speculation. After all, Lumen should continue generating substantial cash flow and has a dividend that management hopes to defend. The firm's base growth rate will also improve following divestitures of declining legacy services such as voice.
But overall, Lumen's ongoing growth struggles, ambitious fiber investment plans, junk credit rating, and weakening dividend coverage continue to make the stock inappropriate for most conservative income investors.
Until management improves the balance sheet and shows an ability to create value reinvesting Lumen's cash in a very competitive industry, the stock will likely continue to look cheap.
