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If you fall outside of the Big Four telecom companies in the United States, you pretty much toil in obscurity. That's the case for Centurylink (NYSE: CTL), a Louisiana-based regional player that's decided to focus on high-end business data solutions to survive in an age of slower growth in its legacy businesses.
If you look at the company's current dividend yield of 7.6% you might get excited. But a little digging would reveal that the company spent $2.16 per share on dividends, while bringing in $1.78 per share in earnings. In other words, the company is paying out more than it brings in.
That couldn't possibly be sustainable, could it???
Oddly enough, it's not a good idea to use earnings to get a gauge on the sustainability of a dividend. That's because "earnings" can be massaged and distorted -- due to accounting rules -- in such a way that they don't really represent the amount of cash a company brings in and keeps during the course of a year.
That's especially true with telecom companies, as they have major infrastructure expenditures that are expensive on the front end, but provide copious amounts of free cash flow over the long run. If we look at Centurylink's dividend payment and free cash flow (FCF) over the past three years, we get a much different view of the payout's sustainability.
Over the past year, Centurylink has only had to use half of its FCF on the dividend -- that's a very healthy rate. In other words, this dividend can definitely survive!
But does that make Centurylink a good dividend stock to buy?
However, most professional investors are well aware of the company's payout from FCF, and yet are still wary about paying up for it (that's why the dividend is so high). It's worth thinking about why.
Centurylink is a small player in a pond that has huge fish -- namely Verizonand AT&T. While those two currently aren't interested in taking away Centurylink's comparatively small business base, that doesn't mean the day won't arrive when the winds shift.
Futhermore, Centurylink had the wherewithal to diversify its offerings into international cloud-computing a number of years ago. The decision was prescient, and helped Centurylink distinguish itself from other rural, landline telecoms that were fading into obscurity.
At the same time, however, it's tough to see what sustainable competitive advantage Centurylink has when it comes to this line of business. As international cloud computing attracts more competition, I find it hard to see how the company could fend off rivals willing to offer the same services for lower prices.
It's not surprising, then, to see why analysts actually expect company earnings to shrink by 4% every year until 2019. You need to have a very specific, forward-looking reason for investing in Centurylink, even with its elevated and sustainable dividend. Right now, I have no such reason, so I suggest steering clear.
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Brian Stoffel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. 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.