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One of the most controversial stocks in the market has to be Lumen Technologies (NYSE:LUMN) and that was before a bombshell quarterly report that fundamentally shifted the investment thesis was released today. You see this communications services company has seen its stock absolutely crushed all year, not unlike other telecom-type company stocks. A lot has been happening here recently. The company just weeks ago completed its ILEC transaction, and it had to sell exchange carrier assets in 20 states as part of this deal. Quarter after quarter questions around the sustainability of the dividend arose as earnings performance continued to weaken. The company has seen an influx of cash from these sales, and also recently sold $2.7 billion worth of assets in Latin America to Stone Peak. There has also been interest in Europeans assets as well. The company does have $25 billion in debt that it is working to tackle, but we have to tell you, we were floored by the decision in today’s earnings report to eliminate the dividend. We had felt the yield was a risky sign, and a possible cut would happen as the dividend is a primary reason to own this and other communication services type companies of this nature. Shares have cratered to levels that are simply attractive now on a valuation basis, and moreover we see the company in a transition phase preparing for its future. We view the stock as a generational opportunity here. Let us discuss.
Revenues were down from last year and missed expectations. Revenue declined 5.5% on a year-over-year basis to $4.328 billion. Adjusting for the sale of its correctional facilities business and controlling for the strong dollar, year-over-year revenue declined 5%. Within both of the company’s two key operating segments, business revenue declined 5.1% year-over-year to $3.155 billion. Ouch. Consensus was slightly missed by $20 million. If we make adjustments for the business line revenue, it still declined 4.3% year-over-year, while the company’s so-called mass markets revenue declined 6.6% year-over-year to $1.173 billion. A tiny bright spot was wholesale revenue grew 1% year-over-year but that channel is likely to weaken.
Earnings were a disappointment too on the bottom line, as expenses are elevated in this operating environment. They reported net income that rose from last year to $578 million compared to $544 million a year ago. That was a positive, and translated to $0.57 in EPS, compared to $0.51 per share for last year. However making adjustments EPS was a measly $0.14 per share for vs $0.49 per share last year. This whiffed versus estimates tremendously. Ouch.
One metric we like for companies like this is EBITDA. Well, considering the drop in other line items, it was not surprising that EBITDA fell from last year. Adjusted EBITDA was $1.659 billion in the quarter compared to $1.872 billion last year. While revenue was down there are pressures from inflationary costs as well as big operational capital expenditures to fund future growth. But with divestitures now complete, the company can focus on a more limited set of business lines, and work to improve operational efficiency. Other moves have been made which will save cash too, despite being catastrophic to shareholders.
Good-bye dividend
So the big news of the day was the dividend was eliminated. Not just cut, as we had expected for months, and had been a concern recently, it is gone. No more. The whopping 15% yield being eliminated changes the investment thesis here. This is no longer an income name. It has morphed into a value and potential growth name. We believe with the moves being made to streamline the business and build cash, while retiring debt, the company will emerge leaner and more efficient. Just in time for new management to take over. Remember, this stock not only fell for much of the year, it really got pounded on the news that the CEO would retire. So, now, we no longer have a company paying about $1.1 billion in dividends per year anymore, which, saves free cash flow, but, oddly, while there has been a ton of pressure, the company’s outlook for free cash flow was quite good. Guidance called for 2022 cash flow to be $2.2 to $2.4 billion, up $200 million at the midpoint. Solid good news in an otherwise kitchen sink quarter.
Strong cash position
Over the last five years, Lumen has significantly improved its balance sheet, eliminating more than $16 billion in debt and reducing annual cash interest expense by more than $1 billion. The company has also pushed out the bulk of its maturities to 2026 and beyond, when hopefully interest rates are more relaxed than they are now for refinancing. Lumen had cash and cash equivalents of $252 million to end the quarter but keep in mind as we mentioned in the open Lumen scooped $5.6 billion in cash upon selling its ILEC business. Further the company has since repaid approximately $3.2 billion aggregate principal amount of its consolidated indebtedness and is redeeming $112 million of senior notes. We like what we are seeing.
Not all hope lost on cash returns to shareholders
We like share repurchases especially when shares are very attractive on a valuation basis. While the dividend is now gone, the company did announce a big repurchase program. Over the next two years, the company will repurchase $1.5 billion in stock. Hopefully the company takes advantage right now with shares in the $5 range to get some bang for their buck. Folks, the market cap is down to $6 billion. They can repurchase 25% of the company with this, and they plan to stay leverage neutral.
Valuation is great
Folks, the valuation is now outstanding here. It was already in value territory, and now we are in deep value territory. With 2022 adjusted EBITDA coming in at $7 billion, we are looking at an EV to EBITDA of 4X. That is solid. The P/E and PEG ratios are but sub 4X. A price to sales of 0.3. And, a price to cash flow of nearly 1X. It really is at levels that are too good to ignore, even as growth has stalled.
Generational opportunity
This company is not going bankrupt. While there is a large debt burden, leverage is reasonable here. Profit metrics are still strong. The company has raised a ton of cash and is tackling the debt. It has pushed maturities out until 2026 for the most part. Capital expenditures will be more focused for targeted growth, while we expect increasing operational efficiency. The company can buy back 25% of its float. Other investors have been crushed. Now we can come in on the back of their bad beats and profit. We like two approaches here. Either selling $5.50 and $5 puts a month out to define your entry and/or reduce your entry point. If you are not assigned, you pocket cash. We think you can also replace that dividend income largely with a buy-write approach. Consider entering here in the $5 range, and selling calls 3 months out about and 15-20% out of the money. If shares rebound, you can always roll the calls for more income.
Your thoughts matter
What do you think here? Good time to buy? Did you get fleeced on this dividend cut? Did they even need to cut the dividend given the better outlook on cash flow? Should they accelerate the buyback? Do you like a buy-write approach? Let the community know below.
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