The Highest Yield in the S&P 500
The timing is right for dividend stocks.
High-yielding dividend stocks are one of the few places left where income investors can harvest a solid income in this low interest rate environment. In addition, the recent extension of the Bush tax-cut laws has increased the favorable tax treatment for dividend income.
Where can you find high dividend yields that are secure?
One of the best dividend sectors of the market has become telecom stocks. These companies have become the high-yielding utilities of the new century. [See: "The Best Utility Stock You can Own"] While growth in the sector has slowed because of wireless saturation and fierce competition, the steady stream of dependable revenue generated by these companies make for great dividends.
Stamford, Conn.-based Frontier Communications Corp. (NYSE: FTR) is the nation’s largest rural telecom provider, operating more than 7 million landlines to residential and business customers in 27 states. The company offers a full array of voice, high-speed Internet and TV services, generating about $6 billion in revenue a year.
The great aspect about investing in Frontier is, of course, the dividend.
Current quarterly dividends of about $0.19 per share translate to $0.75 a year, for a monstrous 7.8% yield at the current price. The yield is more than double the yield of the 10-year U.S. Treasury and high enough to make Frontier the highest dividend yield in the S&P 500.
High yields are great. But, is this one secure?
Free cash flow covered the dividend in the third quarter with a payout ratio of 55%, one of the best in the industry. In fact, the dividend should have room to grow from here, although it will depend on the success or Frontier’s business.
The company has continued to generate highly dependable cash flow with limited and somewhat shrinking revenue. The traditional phone line business is shrinking as more and more customers opt for wireless. While the decline in phone line usage has been less stated in rural communities where Frontier primarily operates, the company is still facing diminishing phone line revenue, which is only partially offset by growth in the broadband (Internet and TV) business.
However, things have just dramatically changed at Frontier.
On July 1, 2010, Frontier closed on a massive deal to acquire assets from Verizon (NYSE: VZ). After the acquisition, Frontier now has more than 7 million access lines, compared with 2.3 million before the deal. Revenue from the acquired business in 2008 was $4.4 billion, more than double Frontier’s revenue of $2.1 billion for the same year.
But these Verizon assets were not nearly as well run as Frontier’s legacy business. This fact represents a problem and an opportunity going forward.
According to analysts at Raymond James, landline losses for the Verizon assets have been growing at a rate of 11% a year, compared with 6% for Frontier. Moreover, revenue at Verizon has been falling at about a 9% clip a year, compared with 3% for Frontier in the last year. Verizon has not serviced these lines as well as Frontier — only 64% of them have broadband availability, compared with 92% of Frontier’s.
Therein lies the opportunity. Frontier has said it intends to bring broadband to 85% of the Verizon lines by 2013. Frontier believes that upgrading the assets will stem the slippage and increase revenue and profit margins.
To free up money to pay down debt and invest in the business, Frontier cut its annual dividend from $1.00 to $0.75 per share in September 2010. While the stock price initially fell on the dividend announcement, it has since recovered and is higher now than before the announcement as investors have realized the benefit of the plan.
The new acquisition is likely to add earnings growth to the steady dividend going forward. In the meantime, the high current dividend should be secure.
Action to Take –> Frontier is still relatively cheap. Raymond James estimates the company will earn $1.11 in free cash flow per share in 2011. That means it is selling at just 8.7 times free cash flow, compared with an industry average of about 27. Frontier’s reasonable value and huge dividend make it a compelling choice for investors looking for a large, safe dividend.
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