A Best Idea with a Tantalizing Yield

Matthew Dolgin: We added CenturyLink to our Best Ideas list in June because the market is pricing in more dire prospects than we expect, and the valuation has gotten too compelling. The stock is trading at less than 4 times our 2019 free cash flow estimate, and it has a dividend yield of almost 9%. We project free cash flow to remain stable at around $3 billion each year throughout our five-year forecast. We also see the dividend as safe because free cash flow should cover it by about 3 times, and we think management would be very reluctant to cut it again after reducing it by more than 50% at the beginning of 2019.

We do see the numerous challenges CenturyLink faces, and we expect sales to fall every year of our forecast. There’s deflationary pricing throughout enterprise networking. Higher-priced legacy offerings are being replaced by low-priced software defined solutions. The company’s consumer network is inferior to cable competitors and has consistently been losing customers. And voice services are on a long-term path toward extinction. We just think these issues are more than priced in, and we expect sales declines to improve as the weaker and lower-margin offerings make up a smaller portion of the company’s total revenue.

Keep in mind that CenturyLink has a lot of debt and therefore more risk, but the maturity schedule and free cash flow generation ease our concerns and make the stock attractive. Our $18 fair value estimate implies more than 50% upside from current levels.