Investors, if you are considering buying stock in Windstream , please ask yourselves this question: "Am I gong to purchase part of a company I think will continue to grow its telecom business, or am I only attracted to its high-yield dividend?"
That's important to determine because in this era of absurdly low Treasury yields (around 1.9% for a 10-year note), Windstream's dividend yield of over 11% exerts a gravitational pull that can easily override common fiscal sense.
Let's take a look at Windstream's first-quarter earnings and try to find an answer.
Total revenue for the quarter declined 2.5% from the same period last year. As a company that is still invested heavily in the sinking wire-line telephone business, that shouldn't come as a surprise.
But the company has been shifting its focus to providing broadband Internet service to consumer and business customers, and those segments have shown growth: Business service revenue is up 2% and consumer broadband service revenue is up 5% over the first quarter of 2012.
Even though Windstream's revenue dropped for the quarter, so did expenses -- by 2.2%, and the company managed a GAAP net income of $0.09 a share. That was a 10% drop from Q1 2012's $0.10 a share.
Do the math
Okay, despite declining revenue overall, Windstream did produce a profit. But how can it afford to pay its $0.25-a-share declared quarterly dividend on $0.09 a share of quarterly net income?
Using the generally accepted formula for calculating free cash flow -- adding back into net income the non-cash expenses of depreciation and amortization, and then subtracting capital expenditures -- gives a free cash flow figure of $61.1 million. But paying out $148.1 million in dividends creates an unsustainable dividend-to-free-cash-flow ratio of 242%.
Frankly, that just can't be sustained, especially with the amount of obligations Windstream is carrying -- $8.1 billion in long-term debt and $671 million in other liabilities. Wouldn't it be better for the company to put at least some of that dividend money toward paying down the debt, or for its capital expenditures?
A quote from Windstream CEO Jeff Gardner in the company's Q3 2012 earnings report may explain Windstream's rationale: "The dividend is a key component of our investment thesis, and we believe it is the best way to provide returns to our shareholders."
Windstream has been a steady dividend payer since 2006 without cutting it once, and that has certainly been a big attraction. But are high dividends a bribe to investors in an attempt to keep the stock price up, or are they really a good business decision?
A cautionary tale
Frontier Communications is another wireline telecom in the declining telephone business. It is also a company that has relied on high dividend yields to attract investors. As a high-yielding dividend payer since 2004, it was a darling with the income investor set until it finally had to face fiscal reality.
Frontier had also been paying out $0.25 a share quarter after quarter, but in 2010 it was forced to cut that to $0.1875. Then, in March 2012, it had to cut it further, to $0.10 a share. It's still a high-yielder at 9.2%, but that's because the stock price has also dropped more than half since that first dividend cut.
Frontier had gotten itself heavily into debt after buying some cast-off Verizon properties -- $8.6 billion worth. It's around that time that the dividend cuts began.
Both Windstream and Frontier are in the same boat, facing the some declines in their legacy phone line businesses. Frontier had to jettison some of its dividend to stay afloat. Will Windstream have to do the same? Yes, Windstream's dividend is a temptation, but is an 11% yield worth the risk of the company spending more on that dividend than it can afford?
Every Frontier investor has to understand that dividends aren't a sure thing. A huge acquisition has transformed the company forever. Will the move bear fruit, or are investors destined for another disappointing dividend cut? In The Motley Fool's premium research report on Frontier Communications, we walk you through all of the key opportunities and threats facing the company.
The article Is Windstream Stock's High Dividend Yield Worth the Risk? originally appeared on Fool.com.Fool contributor Dan Radovsky owns shares of Frontier Communications. 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.