CenturyLink's Dividend X-ray
Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a given company to understand the quality of its dividend and see how that's changed over the past five years.
The company we're looking at today is CenturyLink (NYS: CTL) , which yields 8.2%.
CenturyLink is a rural telecommunications company that has been pursuing a strategy of growth through mergers. The past few years, CenturyLink has spent roughly $38 billion buying Embarq -- a spinoff of Sprint Nextel (NYS: S) -- as well as Qwest and Savvis. Similarly, competitor Frontier Communications (NYS: FTR) greatly expanded its own size by making a huge move in 2010 to buy Verizon's (NYS: VZ) rural-wireline business.
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years, and, if so, how much has it grown.
CenturyLink's dividend took a big jump in 2008 with the acquisition of Embarq.
To understand how safe a dividend is, we use three crucial tools, the first of which is:
- The interest coverage ratio, or the number of times interest is earned, which is calculated by earnings before interest and taxes, divided by interest expense. The interest coverage ratio measures a company's ability to pay the interest on its debt. A ratio less than 1.5 is questionable; a number less than 1 means the company is not bringing in enough money to cover its interest expenses.
CentruyLink covers every dollar of interest expense with just over $2 in operating earnings.
The other tools we use to evaluate the safety of a dividend are:
- The EPS payout ratio, or dividends per share divided by earnings per share. The EPS payout ratio measures the percentage of earnings that go toward paying the dividend. A ratio greater than 80% is worrisome.
- The FCF payout ratio, or dividends per share divided by free cash flow per share. Earnings alone don't always paint a complete picture of a business's health. The FCF payout ratio measures the percent of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Source: S&P Capital IQ.
CenturyLink's payout ratio has remained steady near 50%, while its earnings payout ratio has been more volatile.
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