VZ - Lumen: 9% Yield Good Dividend Coverage

• Lumen yields 9.48%, with a 32% Free Cash Flow Dividend Payout Ratio.
• Lumen just reported Q2 earnings this week, which were impacted by currency exchange and the end of CAF II subsidies.
• Management reiterated 2022 guidance for maintaining a $0.25 quarterly dividend.

Like many other traditional telecoms, Lumen Technologies, Inc. ( LUMN ) has been moving into other business offerings over the past few years in order to fight the attrition associated with traditional landline service.

Management has expanded fiber optics, multi-gig services, and other architectures at an accelerated pace, which it sees as positioning LUMN for growth coming from Virtual Reality, AR, gaming, work and learn from home, and other high-bandwidth services.

As we've written in our previous articles on LUMN, another of its big challenges is working down its debt load, which was $35B-plus in 2018. They paid down ~$900M so far in 2022, and ended Q2 '22 with $27.76B in Net Debt, down -2.85% vs. Q2 '21. Interest Expense has continued to improve - it dropped 10.87% in Q1-2 '22.

A positive development on the debt payoff front is that management completed the sale of LUMN's Latin American assets on 8/1/22 for $2.7B. A certain % of that cash will be utilized to pay down more debt in 2022.

LUMN also has in sight the sale of its 20-state ILEC business, which management expects to close in Q4 '22, for ~$3-4B.

LUMN's next major debt maturity is in 2023, when it will have $949M maturing, followed by $1.125B in 2024, and a much bigger ~$4B amount in 2025.

Compared to its biggest peers, LUMN's Debt/Equity is high, while its Net Debt/EBITDA of 3.59X is the 2nd highest in the group. EBITDA/Interest coverage looks solid, albeit in the lower part of the peer group. ROE is the 3rd highest in the group.

Earnings:

LUMN just reported Q2 '22 earnings this week, with weak results. Revenue was down -6%; Adjusted EPS fell to $0.35, vs. $0.45 in Q2 '21; and Adjusted EBITDA fell -15.6%, to $1.76B.

LUMN's Q2 Revenue mix saw its Enterprise channels improve to 54.4%, and Wholesale also improved to 10.7%. Management has been shifting the emphasis away from Mass Markets over the past few years - fell to 25.9%, vs. 28.5% a year ago. The expected Q4 '22 closing of LUMN's 20-state ILEC divestiture should further benefit its enterprise revenue mix.

Fiber Broadband revenues were the bright spot in Mass Markets, rising 16% vs. Q2 '22, but are still the smallest component, at 13%. The Voice and Other category fell ~-30%, impacted by non-recurring CAF II revenue of $122M in Q2 '21.

Within the Enterprise channel revenue mix, Voice & Other fell to 20.5% vs. 22.2% in Q2 '21, with Core products rising to 79.5%. International and GAM was down slightly, at -1.5%, with Large Enterprise declining -6.5%, and Mid-Market falling -5.3% vs. Q2 '21.

The strong U.S. dollar caused most of the decline in International & IGAM - on a constant currency basis, IGAM revenue was flat year-over-year. Large enterprise growth was negatively impacted by IT solutions business, which is lumpy on a quarterly basis.

Free Cash Flow was $668M, vs. $993M in Q2 '21:

During Q2 '22, LUMN added 28,000 Quantum Fiber customers, ~in line with Q1 '22, bringing the total Quantum Fiber subscribers to 858,000.

LUMN's earnings were affected by the end of the CAF II program at year-end 2021. This was an FCC program designed to expand access to voice and broadband services for areas where they are unavailable. Through CAF Phase II, the FCC provides funding to service providers to subsidize the cost of building new network infrastructure or performing network upgrades to provide voice and broadband service in areas where it is lacking.

Revenue was down -6.7% in the 1st half of 2022, with EBITDA falling -15.6%, Free Cash Flow down -20.5%, and Net Income down by -3.87%. The bright spot was Adjusted EPS, which rose by 7.69%, aided by a -7% decline in the share count:

2022 Guidance:

Management reiterated its previously issued 2022 guidance from Q1 '22, which called for an Adjusted EBITDA range to $6.9B - $7.1B, vs. the previous $6.5B - $6.7B. They also raised the 2022 Free Cash Flow guidance range to $2 - $2.2B, up 25% vs. the previous $1.6B - $1.8B range.

Of key interest to income investors, management committed to maintaining the current $.25 quarterly dividend in 2022.

Management is rolling out a new ultra-fast Internet offering in select areas, with 3 GB/second for $150/month, and 8 GB/second for $300/month.

They are also re-grouping LUMN's business revenue reporting into 4 product categories: Grow, Nurture, Harvest, and Other.

The Grow category features products such as IP, wavelengths, security, cloud, SD-WAN, SASE, unified communications and voice over IP.

The Nurture category includes VPN and Ethernet, among its products.

The Harvest products include legacy services such as voice, Private Line and UNEs.

Other products are equipment and IT solutions, which tend to fluctuate quarter-to-quarter and are low-margin contributors.

Dividends:

At its 8/4/22 intraday price of $10.55, LUMN yields 9.48%. It should go ex-dividend next on ~ 8/26/22, with a 9/12/22 pay date. Management cut the quarterly dividend from $.52 to $.25 in Q1 '19, in order to reallocate more cash toward debt repayment, hence the -13.43% 5-year dividend growth rate.

Looking at LUMN's dividend sustainability via Adjusted EPS shows a 7% improvement in its dividend payout ratio in Q1-2 '22, to 51.02%, with a trailing 12-month ratio of 50.51%.

On a Free Cash Flow basis, though, the payout ratio rose by 16%, to 36.64%, vs. 31.52% in Q1-2 '21, with a trailing ratio of 32.30%. Still, both payout ratios offer a comfortable cushion for the $.25 quarterly dividend.

Valuations:

Rather than compare LUMN to the overall Telecom industry, we constructed a table of comps vs. its biggest peers. With its post-Q2 earnings decline, LUMN is now selling at a 12% discount to Book Value, the 2nd cheapest valuation in this group, behind AT&T ( T ), with its .78X P/Book valuation.

LUMN has the lowest valuations in this group on for trailing non-GAAP P/E, Price/Sales, and EV/EBITDA, in addition to the highest dividend yield, 9.48%:

Analysts' Price Targets:

At $10.55, LUMN is 1.39% above analysts' $10.40 average price target, and 15.6% below the $12.50 highest price target.

Performance:

While LUMN has outperformed the Telecom industry over the past quarter, year, and so far in 2022, it has lagged the market during all of those periods.

Parting Thoughts:

Hmm, the dividend appears safe, and management continues to pay down debt, but earnings have been challenging. The $6-7B in its divestitures should aid in more debt pay-downs in the 2nd half of 2022.

As long term shareholders can tell you, it has been a long, painful ride with LUMN - they've seen it fall from the mid-$40's in its CTL days down to below $9.00 in 2020. Shorter term investors, in since ~Q4 '20, have had a better ride.

We rate LUMN a speculative BUY. You may want to look at selling put options below its price/share, as extra insurance against further price declines.

If you're interested in other high-yield vehicles, we cover them every Friday and Sunday in our articles .

All tables furnished by Hidden Dividend Stocks Plus, unless otherwise noted.

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