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| The Basics | Telecom relics rolling in cash
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Phone exchanges that serve the boondocks wont grow tons. But some are rolling in cash and paying rich dividends to their stockholders.
By Harry Domash
Despite the hullabaloo about AT&T's (T, news, msgs) proposed takeover of BellSouth (BLS, news, msgs), theres one telecom sector that isnt getting any respect.
Rural local telephone exchange carriers are appropriately abbreviated RLECs because most pundits view them as relics.
RLECs serve rural areas, typically with population densities only 10% of urban markets. RLECs provide traditional wireline local and long-distance voice-telephone services plus DSL and dial-up Internet services. Some also offer wireless services.
Many of the RLECs were created by investment groups which purchased the assets from larger carriers and later took them public.
The big carriers unloaded the RLECs because of their dismal growth prospects. Most RLECs are not growing sales much and, in some cases, sales are shrinking. The reasons are simple. Households and even businesses need fewer phone lines than they did a few years ago. For starters, you can usually ditch one phone line when you switch from dial-up Internet access to DSL or cable. Further, some consumers are giving up their land-lines altogether and using cell phones for everything.
Related news and commentary on MSN Money
Paying out the profits
Given those growth prospects, RLECs get scant attention from Wall Street, which is mostly focused on spotting the next Google (GOOG, news, msgs).
But some RLECs have one thing going for them that growth stocks dont -- they pay big dividends.
Because theyre not spending much on expansion, these RLECs are generating large and stable free-cash flows. Rather than hoard the money, theyve decided to give it to shareholders as dividends and sometimes by buying back shares. By focusing on these particular RLECs, you can get relatively stable dividends equating to 6% to 11% yields.
How do you find the high-dividend RLECs? MSNs Deluxe Screener is a good place to start.
I ran a screen looking for domestic telecom stocks paying dividends equating to at least 6% yields.
Screening parameter: Industry Name -- Telecom Services -- Domestic
Screening parameter: Dividend Yield >= 6
I picked 6% because thats a high enough dividend yield to discourage share-price downdrafts triggered by short-term bad news.
For example, assume that a stock trading at $20 per share is expected to pay dividends totaling $1.20 over the next 12 months, which equates to an expected 6% yield ($1.20 divided by $20). Now, assume bad news happens -- say, an earnings miss, due to unexpected nonrecurring expenses, and the share price drops to $15. The share-price drop brings the dividend yield up to 7.5%. Assuming that the dividend is seen as safe, the higher yield would attract more buyers, which would tend to move the share price back up.
My screen listed only five stocks.
| RLECs yielding big dividends | | Company name | Dividend yield | | Alaska Communications Systems Group (ALSK, news, msgs) | 7.5% | | Citizens Communications (CZN, news, msgs) | 7.5% | | Commonwealth Telephone Enterprises (CTCO, news, msgs) | 6.3% | | Iowa Telecommunications Services (IWA, news, msgs) | 9.1% | | Valor Communications Group (VCG, news, msgs) | 11.6% |
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Naturally, Valor Communications got my attention. However, I found that the 11.6% dividend yield listed by the screener, which is based on the most-recently announced quarterly dividend, doesnt accurately reflect Valors future dividend prospects.
In December 2005, Valor entered into an agreement with Alltel (AT, news, msgs), a large rural carrier that decided to jettison its land-line business to focus solely on the higher-growth wireless (cell phone, etc.) business.
In a complicated transaction, Alltel will spin off its fixed-line business into a separate company that will immediately merge with Valor. When the deal is done, existing Valor shareholders holdings will be diluted and the dividend yield is expected to drop to the 7% to 8% range. Given the uncertainties involved, I dropped Valor from my list.
However, while experimenting with screening parameters, I found two additional RLECs that werent turned up by my original screen.
| More RLECs | | Company name | Dividend yield | | Consolidated Comm Illinois Holdings (CNSL, news, msgs) | 10.3% | | Fairpoint Communications (FRP, news, msgs) | 11.2% |
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My original screen didnt list Consolidated because its dividend yield was incorrectly shown as 0%. Fairpoint was erroneously included in the wireless category.
All of the RLECs listed offer local and long-distance land-line, Internet and related services to business and residential customers. Alaska Communications and Citizens Communications also offer wireless services. Heres a summary of the services, areas of coverage and the trailing 12-months revenues: - Alaska Communications: Serves all of Alaska with wire-line and wireless services. Trailing 12-months sales: $327 million.
- Citizens Communications: Citizens is the largest of the group, operating rural and suburban carriers in 24 states with wire-line and wireless services under the Frontier name. Trailing 12-months sales: $2.2 billion.
- Commonwealth Telephone Enterprises: Commonwealth offers wire-line services in eastern Pennsylvania. Its Condor Technology Solutions (CTSI, news, msgs) subsidiary offers competitive (non-exclusive) wire-line services in other regions of Pennsylvania. Trailing 12-months sales: $337 million.
- Consolidated Communications: Provides wire-line services in Illinois and Texas. Trailing 12-months sales: $186 million.
- Fairpoint Communications: Operates 28 rural telephone companies offering wire-line services in 17 states. Trailing 12-months sales: $263 million.
- Iowa Telecommunications Group: Provides wire-line services in Iowa. Trailing 12-months sales: $557 million.
Safe from cable
All land-line telephone service providers, large or small, hope to offset losses in land-line revenues with steadily increasing DSL revenues. However, theres a fly in that ointment. When it comes to DSL, the telecoms have plenty of competition. Cable companies offer, at least in the eyes of most consumers, virtually the same product at the same price. Even worse, cities around the U.S. are gearing up to offer free wireless Internet connections, and that trend appears to be accelerating.
However, the DSL competition wont be as intense for RLECs. For starters, many of their customers arent served by cable. And, obviously, its not easy to offer free wireless services across the long distances out in the boondocks.
The potential downside
Those high dividends are for naught if your stock price drops significantly. Generally, high-dividend yields, compared with other stocks in the same group, signal that at least some investors see the stock as risky, probably because they think the dividend cant be sustained at its current level. Thus, its important that you verify a firms ability to maintain its dividends.
Whats critical is that operating cash flow must comfortably cover the dividends. You can check that on the cash-flow statements (Financial Results >Statements). Compare Net Cash from Operating Activities to Payment of Cash Dividends listed in the Cash Flow From Financing Activities section. The quarterly statements are most useful, but keep in mind that the figures shown for each quarter are year-to-date totals.
Find out all you can about each RLECs business prospects. The more you know about your stocks, the better your results.
At the time of publication, Harry Domash did not own or control shares of companies mentioned in this column.
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