CCI - Crown Castle: Remains Solid After Q1 Earnings

2023-04-25 03:20:31 ET

Summary

• I started coverage on Crown Castle in February. Since then the stock has dropped by about 10%. Last week it reported Q1 2023 earnings.
• Beyond the Sprint-related cancellations and higher interest expense, organic growth has remained solid.
• Dividend growth is likely to slow over the short to medium-term but long-term the potential is certainly there making CCI a good income-oriented investment.
• I present my updated outlook for the company.

Dear readers/followers,

I started coverage on Crown Castle Inc. ( CCI ) in mid-February. In the original article I presented by bullish thesis for cell towers and outlined the main differences between American Tower Corporation ( AMT ) and CCI, stating a slight preference for AMT despite its lower dividend yield, but ultimately rating both as a buy. Since then CCI has dropped from $141 to $126 per share (-10.6%) while AMT dropped from $216 to $204 per share (-5.5%). Last week Crown Castle reported its Q1 2023 results so today I want to present a deep dive into the earnings report and an updated outlook for the company.

Q1 results came in in-line with expectations, raising no major issues. Organic growth in rental revenue reached 6.5% YoY (or 3% when adjusted for the impact of the Sprint cancellations) while AFFO climbed by 2% YoY to $1.91 per share confirm that on an operational level the business is doing quite well.

The 2023 outlook has remained unchanged as management highlighted two short-term hurdles that will affect the near-term outlook of the company. The first hurdle relates to Sprint cancellations. As I've discussed in my previous article, this has to do with the fact that the telecommunications provider Sprint has merged with T-Mobile. Since both of these companies were tenants of Crown Castle, as they consolidated the business, most of the technology that was previously leased by Sprint is no longer needed (i.e. there is no need for two same antennas on the tower). Therefore the leases have been terminated. The second hurdle has to do with high interest rates that inevitably lead to a higher interest rate expense.

The combination of these two hurdles will drive short-term results. In particular the full year expected impact from Sprint cancellations remains unchanged with non-renewals of $30 Million and an accelerated payment of $160-170 Million. In Q1 the company already received $48 Million in accelerated payments and the remaining $110 Million will be received in the second quarter. As a result, Q2 results are likely to represent the high watermark for rental revenues and AFFO in 2023. With regards to the increase in interest expense management expects an increase in cash interest expense of $120-160 Million. The aftermath of this should be a 4% YoY increase in rental revenue over the course of 2023 and a 3% growth in AFFO to $7.63 per share. The growth in 2023 is expected to be fuelled by a 5% organic growth (adjusted for Sprint cancellations) in the towers segment and an 8% growth in small cells.

Managements expects that dividend growth will be minimal until 2025 despite strong projected underlying growth, due to the aforementioned hurdles. That means that the dividend is likely to stay at $6.26 per share or a 5.0% yield. That's a forward payout ratio of 83% which given the high visibility of earnings is quite ok.

Looking past these discrete items management states:

we believe our strategy will allow us to deliver on our long-term target of growing dividends per share at 7% to 8% per year.

And I believe them. Since they established their target of 7-8% dividend growth in 2017, they have overdelivered and increased the dividend with a CAGR of 9%. Given the industry tailwinds with likely a decade long development of 5G ahead I see no reason why they shouldn't be able to continue to deliver, once the economy stabilizes and rates decrease at least a little. In the meantime you will get paid a reasonable 5% dividend to wait.

What's also important is that they have been able to deliver these results while significantly limiting risk. This is reflected by the fact that unlike AMT they have continued to focus solely on the US market, which is considerably safer, with a more established legal system which means that CCI doesn't have to worry about tenants not paying them nearly as much as AMT. Moreover, they have a stellar BBB rated balance sheet with 88% of the debt fixed-rate, minimal near-term debt maturities and a weighted average interest rate of just 3.7%. That's basically equal to 10-year treasury yields right now.

With regards to valuation I see no reason to move my price target established in the original article. Continuing to value the company at 22x FFO and assuming no FFO growth until 2025 I'm sticking to my PT of $166 per share. That's a solid 33% upside from here in addition to a 5% dividend reiterating the " BUY " rating for CCI here at $125 per share. Personally I'm an even bigger fan of AMT, because of their international exposure, which although riskier, allows them to generate a significantly higher ROIC. But for income oriented investors that depend on the dividends to cover their living costs, I can definitely see the appeal in investing in Crown Castle.

This is supported by high level technical analysis as we now sit near the Covid and October 2022 low. From here a quick stop loss hunt below $122 would make sense in order to get liquidity for the move up. Another level where a reversal would make sense is around $110 per share - this is where I would add to my position.

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