Better Buy: Frontier Communications Corporation vs. Sprint

By Markets Fool.com


Telephone poles are becoming a thing of the past for major telecom companies. Image source: Getty Images.

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The telecom industry has been an area of huge transformation in recent years. Once seen as a stolid, utility-like sector, the growth of wireless communications opened a completely new market for telecom providers, and Frontier Communications and Sprint have both jumped into the fray to stake their claims to the fast-growing industry. Having started as a telecom company focused on rural areas, Frontier has worked to build up its assets largely by buying business from larger rivals. Sprint has built on its past as a long-distance telephone service provider to build up a sizable wireless network of its own. Investors looking at the space see big challenges ahead, and they want to know which company can weather coming storms better. Let's take a closer look at Frontier and Sprint, comparing them on a number of metrics to see which one looks more attractive under current conditions.

Valuation and share performance

Both Frontier and Sprint have delivered for shareholders over the past year, but Sprint has more than doubled the returns that Frontier has produced. Sprint's total return since July 2015 is 24%, compared to just 10% for Frontier. Yet when you look back further, Frontier has done a better job of holding its value than Sprint, which has lost three-quarters of its value over the past decade.

Determining valuations for the two telecom companies is difficult because both Sprint and Frontier have posted GAAP losses recently. However, using some other common valuation metrics, Sprint appears to have the cheaper valuation. On a price-to-sales basis, Sprint trades at less than 60% of its trailing-12-month sales, compared to about 105% for Frontier. Similarly, when you use pre-tax earnings before interest, depreciation, and amortization (EBITDA) and compare it to the two companies' enterprise values, Frontier stock currently trades at a multiple of almost 9.5. Sprint's similar enterprise-value-to-EBITDA ratio is just 6. Despite its recent share-price rise, Sprint's longer-term losses have left it with a lower valuation than Frontier.

Dividends

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However, one area where Sprint can't keep up with Frontier is in dividends. Sprint no longer makes quarterly payments to shareholders. By contrast, Frontier is well-known for having extremely high dividend yields, and few other stocks in the market can match its current 8.5% yield.

Image source: Frontier.

One concern that some investors have about Frontier is that it doesn't earn enough to cover its dividend payments on a GAAP basis. Yet free cash flow has been ample to pay the dividend, and Frontier actually boosted its payout last year, albeit after a couple of dividend cuts that reduced its overall payout by 60%.

Still, Sprint seems unlikely to start paying a dividend anytime soon. Early in its history, the company consistently rewarded shareholders with quarterly payouts. But an 80% cut in 2005 reflected the demise of the long-distance telephone industry, and Sprint suspended its dividend entirely in early 2008. For those needing income, Frontier has a clear advantage.

Growth prospects and risk

Telecom companies are fighting each other to grow, and that has produced intense competition. Frontier's recent $10.5 billion acquisition of valuable assets in Texas, Florida, and California has the prospect to boost the size of the telecom's total business immensely. Yet in order to succeed, Frontier will have to do a good job of getting those newly acquired customers to stick with their new provider and ideally purchase a broader range of services as well. The acquisition strategy is one that Frontier has used many times in the past, and bullish investors hope that the company has learned from its mistakes and will find new ways to squeeze more revenue from its new customers. In particular, more than 2.2 million broadband connections have the capacity to build out Frontier's exposure significantly, and CEO Dan McCarthy has to hope that the company will coax voice and pay-television customers toward the lucrative broadband end of the business as well.

Image source: Sprint.

Meanwhile, Sprint has been working hard at containing costs and improving its financial condition. In January, the company cut more than 2,500 jobs, including positions at its Kansas headquarters as well as customer care centers around the country. That and similar moves are aimed to save Sprint as much as $2.5 billion in costs, but ongoing losses continue to hurt Sprint as it seeks to fight back in price wars involving the other three major U.S. carriers. The problem for Sprint is that rivals are expanding their network size and quality, and Sprint can't afford to let itself fall behind. Also pressuring Sprint is a general slowdown in smartphone demand, and if customers choose to upgrade their devices less often in the future, it could add up to even more challenges for Sprint in trying to grow its business.

Both Frontier and Sprint face big challenges, but Frontier looks like the better buy right now. If Frontier can capitalize on the huge opportunity that it has to consolidate its recent acquisition and use it to generate even more business, then it could become an even bigger player in the telecom space. Sprint faces an uphill battle against stronger rivals, and its share price doesn't offer the margin of safety that many investors need to justify a speculative purchase.

The article Better Buy: Frontier Communications Corporation vs. Sprint originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.