UNIT - Uniti: 2023 AFFO Gets Crushed As Interest Expense Racks Up

2023-03-06 08:07:07 ET

Summary

• In our last piece, we talked about why Uniti common shares were still a poor investment choice.
• We looked at the bonds as a relatively better bet.
• 2023 estimates validate the risks on the common shares.

When we last wrote on Uniti Group Inc. ( UNIT ) we suggested that there was no meat left on the bone for the equity. The bonds were another matter and possibly offered a better risk-adjusted play.

So if you really had the itch to play it, the bonds would be the way to go. Here you would be confronted with the secured and the unsecured debt and there is a huge difference in yields and ratings. Nonetheless, both are interesting options for a longer-term play on the company, relative to the common equity. We rate the common equity at "hold", which is a big upgrade from the Strong Sell ratings the last time around.

Source: 14% Yielding Debt A Far Better Option Than The Equity

The stock has heavily underperformed the market since then, running at a brisk 75 plus annualized rate.

What ails this company and did the Q4-2022 results rearm the bears? That is what we look at next.

Q4-2022

Q4-2022 was a steady quarter for the company as you can see by the year over year flatlining of all things relevant.

While there was a small "miss" based on consensus estimates, we don't think that was remotely relevant for the story. The real driver was the guidance where UNIT came up short on 2023 revenues and adjusted funds from operations ((AFFO)). While revenues and adjusted EBITDA are expected to grow slightly, they were short of where the analyst community was. The small delta there alongside the rather massive change in expenses, meant that AFFO was going into a freefall.

What expenses are driving this? Well UNIT gives you that answer in the next slide.

Despite baseline operations adding 10 cents a share, financing and interest impacts robbed 46 cents from AFFO. Where:

Uniti Group Inc. today announced that its subsidiaries, Uniti Group LP, Uniti Fiber Holdings Inc., Uniti Group Finance 2019 Inc. and CSL Capital, LLC (together, the “Issuers”), have upsized and priced their offering of $2,600 million aggregate principal amount of 10.50% senior secured notes due 2028 (the “New Notes”), which is an increase of $850 million over the previously announced amount. The New Notes will be issued at an issue price of 100%. The Issuers intend to use a portion of the net proceeds from the offering to fund the redemption in full (the “Redemption”) of Uniti’s outstanding 7.875% senior secured notes due 2025 (the “2025 Secured Notes”), including related premiums, fees and expenses in connection with the foregoing.

Source: Seeking Alpha (emphasis ours)

We have highlighted the relevant portions of that press release. First of all, kudos to UNIT on the timing there. The CCC spread or below high yield spread had notably decreased in in the new year and UNIT rightly upsized their offering to take out the risk of the nearest maturities.

Despite this obvious move, which substantially increases financing costs (by about $68 million annually), analysts were off the mark by a wide margin. They had to drop their estimates and those were followed by lower price targets.

The Big Hurdles Ahead

While UNIT has taken out the biggest risk to their debt structure substantial challenges remain. The first of these relates to what exactly is the earnings power and free cash flow of this firm. Let's walk you through some numbers related to this. The FFO estimate is $1.04 per share for the year ahead.

Now, this is way lower than the AFFO shown above ($1.39), so what makes up this difference? It cannot be that the analysts are forecasting something so radically different than what the company is telegraphing. The answer lies in the adjustments from FFO to AFFO.

Our comments there are that those add backs are actual costs and those "maintenance capital expenditures" look woefully low relative to even the non-real estate depreciation. But they are what they are and it is up to investors to decide whether FFO or AFFO represents the earnings potential of the firm. From our point of view, both numbers are relatively irrelevant. What number actually matters is the net free cash flow and that looks weak, whether you subtract our "success based capex" from FFO or AFFO.

We will note here that before dividends but after capex, the company has no free cash flow. We will also note that this is in a year where the refinancing was not applicable for the full year (notes closed on February 14, 2023). So you can see how things can get dicey.

Next up in the hurdles for the company are the small amounts on the credit facility and the June 15, 2024 notes.

While the total amounts may seem relatively small, keep in mind that after the mandatory dividends that the REIT will pay in 2023 and 2024, UNIT will be burning through cash. With that heavy cash burn, refinancing those two will be painful and likely come at far higher rates. Even the nearest maturities are trading at 10% rates.

When you add this into the longer term equation, one thing becomes clear. UNIT is not designed to survive at these interest rates. This does not require a leap of faith. Just some basic math. With a $925 adjusted EBITDA run-rate, you already have 2023 interest and capex exceeding that.

The final hurdle is financing the dividend, which they have to pay as a REIT. If you subtract dividends, you are cash flow negative to the tune of $150 million (given 2022 run-rates).

The interest expense is also for the full year and does not really reflect a Q4-2023 run-rate. The variable rate credit facility will be higher as we get to the end. So realistically we will be seeing a $600 million annualized rate in Q4-2023. There is no self sustaining model in sight and only cash burn as far as the eye can see. We have written about the problem with this model many times (See, The Old Dividend Is Never Ever Coming Back At Uniti ) and where we have always disagreed with the bulk of the analysts community is our position on capex.

We see the entire success-based-capex as maintenance capex.

By our logic, UNIT can never decrease this, nor has it contributed to any growth. In case you disagree, do note that FFO per share will be the lowest it has ever been in 2023.

Verdict

We have left out all the Windstream disputes from our discussion as those will not matter on any reasonable timeframe. Where they might matter is if UNIT tries to place longer term debt that crosses 2030.

Windstream is debating the interpretation of future rent beyond that point and certainly any debt that matures beyond that will require 4-7% premium above even the double digit rates we see today. None of that will ultimately matter in our opinion as UNIT's broken model will run into a brick wall, way before that. Watch the cash flow and watch the interest coverage. Calculate what would happen if the debt stack got refinanced at 2-4% higher rates. If you do that you will likely reach the same conclusion as us. The senior secured notes are possibly the only long trade worth indulging.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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