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Income Investing

Mixed Results

By Roger S. Conrad, on Sep. 3, 2013

Each quarter, the big question for Consolidated Communications is whether the company’s revenue from broadband subscriptions outpaces customer attrition in its shrinking local landline business.

As we discussed in How Safe Are Telecom Dividends?, smaller names that have failed to grow their data business at a faster rate than their legacy voice services have all cut or eliminated their payouts. Two of these small fry, Otelco (NSDQ: OTEL) and FairPoint Communications (NSDQ: FRP), found these challenges to be insurmountable and filed for bankruptcy.

Shares of Consolidated Communications yield 9.2 percent, reflecting investors’ concern that the company will succumb to the same pressures. Short interest represents 5.55 percent of the stock’s total float–equivalent to 15 days of normal trading.

But Consolidated Communications’ results have defied the doomsayers consistently. In the second quarter, the company grew its cash flow by 13.5 percent from year-ago levels, fueled by a 7.1 percent uptick in data- and video-related revenue.  The successful integration of the SureWest (acquired last year) has also provided a boost; synergies from the first year of combined operations exceeded management’s target by 10 percent.This solid performance translated into a dividend payout ratio of 60.9 percent.

Excluding the contribution from SureWest, Consolidated Communications’ second-quarter revenue was flat from a year ago; revenue from the company’s traditional voice business declined by 4.3 percent year over year, while the firm also disposed of its prison-services business after Illinois awarded the contract to a new provider.

With data and video accounting for 79 percent of Consolidated Communications’ top line, the extent to which customer attrition in its legacy voice-services business affects overall results will diminish with each quarter.

To further this effort, the company continues to build out direct fiber and hybrid fiber cable; management estimates that the firm can deliver advanced services to about 42 percent of the marketable homes in geographic footprint. Consolidated Communications also added 79 agreements to provide wireless backhaul services to carriers, bringing the total number of towers under contract to 776 at the end of the quarter. Meanwhile, the cash distributions that the firm received from its five partnerships with Verizon Wireless increase by 30 percent from year-ago levels, to $7.7 million.

Amid these encouraging developments, two perennial concerns hover over Consolidated Communications: the phase-out of universal service subsidies for rural telecommunication providers and potential competition from Google (NSDQ: GOOG) in broadband service.

In a conference call to discuss second-quarter results, management outlined a plan to offset reduced subsidies through rate increases. Meanwhile, Google’s efforts to date have remained complementary rather than competitive.

At present, all indications suggest that Consolidated Communications’ generous quarterly dividend appears safe; not only does the company generate ample cash flow to support this payout, but also the firm’s strong financial performance should enable it to strengthen the balance sheet and fund its broadband rollout.

Having increased their shareholdings by 10 percent over the past six months, insiders evidently agree with our assessment. Wall Street’s opinion of the stock has also improved; four analysts rate the shares a buy, while the name also garners one hold rating and one selling rating.

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