Lumen Technologies’ Q3 Results Answered Our 3 Biggest Questions

Summary

We bought the dip in LUMN this past summer after the market sold it following management’s announced dispositions.

Q3 results validated our investment thesis.

We discuss the 3 biggest takeaways from Q3 results and how they impact our thesis.

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shulz/E+ via Getty Images As our regular readers and members at High Yield Investor know, we have been bullish on Lumen Technologies ( LUMN ) ever since they announced their major asset sales this summer, hinted at a dividend cut next year, and the stock fell in response: Data by YCharts Our thesis was essentially that these asset sales and the reduced share price tipped the risk-reward profile of the stock decisively in the favor of longs for the following reasons: LUMN’s focus on its large, dense, and strong fiber network in the U.S. positions it nicely for a return to top-line growth in the next few years.

It offers an attractive dividend that is well covered by the company’s $2 billion plus in annual free cash flow generation.

Management recently held an analyst day where it made the case that they are about to enter a growth phase after focusing the past several years on positioning their fiber network for the “fourth industrial revolution”.

While our biggest concern had been the heavy debt burden on the balance sheet, management has recently prioritized paying down debt and refinancing outstanding loans to reduce interest costs while simultaneously improving the debt maturity ladder.

Furthermore, the asset sales position the company to accelerate investments in key growth areas and gives it greater flexibility on capital allocation, allowing for debt reduction and the continued evaluation of share repurchases

While Mr. Market sold the stock on the news, LUMN became suddenly much more palatable to us as their already decently manageable debt maturity profile should be a piece of cake after this sale, making their leverage much less of a concern. source: Investor Presentation

Furthermore, LUMN’s enhanced financial flexibility positions them well to invest in growth projects and/or buy back deeply discounted shares as they see fit without having to contemplate cutting their dividend. With a fat dividend yield now well secured by free cash flow and an enhanced financial outlook, LUMN can focus more on truly generating long-term growth on the top and bottom lines and even possibly buy back shares to force Mr. Market to push shares higher. Ultimately, we decided that the risk-reward was now attractive enough for us to buy in.

Now, just a few weeks later, LUMN largely validated our investment thesis when it reported its Q3 FY2021 results . In particular, they answered our three biggest questions about the investment thesis here: #1. How Much Would The Dividend Get Cut Next Year?

The biggest surprise from the quarter was LUMN’s sudden shift on its dividend policy. Management – in a seeming about face – made it clear that maintaining the dividend is one of its top priorities: …we have no plans to modify our dividend, which we believe is sustainable at the $1 per share level. Although our payout ratio will likely rise in the near-term as we streamline our asset portfolio and invest in the Quantum and Enterprise opportunities, we expect our focused operations to provide the underpinnings for top-line growth in 2 years to 3 years, which we expect will drive a more normalized dividend payout ratio over time. After strongly implying last quarter that the dividend was likely to be cut next year after its asset sales close, management stated on this earnings call that one of its top priorities is to “maintain the $1 per share dividend.” Given that the yield is very attractive and the dividend payout is well covered by free cash flow, this is very welcome to us as income investors. #2. How Aggressively Would Management Implement Its Share Buyback?

On top of maintaining the dividend for the foreseeable future, management announced that it has already leveraged some of its immense free cash flow generation to complete its $1 billion stock buyback program as of October 2021, effectively buying back 7% of the company in just a few months: As you’ve seen, we completed the $1 billion share buyback that we announced last quarter, reducing our share count by about or $81 million shares, or approximately 7% of our total shares outstanding. I will also note we […]

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