A few days ago, CenturyLink joined the February 2013 dividend-cutting club by slashing its quarterly payment from $0.725 per share to $0.54 per share. Other companies also announcing dividend cuts in early February include Exelon and Cliffs Natural Resources. But unlike with Exelon and Cliffs Natural Resources, Moody’s reaction to the dividend cut was quite negative, placing the CenturyLink’s debt ratings on review for downgrade. What makes CenturyLink different from Exelon and Cliffs Natural Resources? It has to do with what the money saved from the dividend cut will be used for.
CenturyLink announced its dividend cut as part of a revised capital allocation strategy that includes the authorization of a $2 billion stock repurchase program. The press release also noted that the company plans to maintain leverage at less than 3.0 times EBITDA. As Moody’s noted in its February 13 ratings action press release, on its own, the dividend cut would be viewed favorably, even if the money saved from the dividend cut were directed to share repurchases. But given that the $2 billion share repurchase program exceeds the amount of cash saved from the dividend cut, and given “CenturyLink’s decision to abandon its prior longstanding leverage target (Debt to EBITDA) of the low two’s to 2.5 times,” Moody’s felt it necessary to put approximately $20.6 billion of debt on review for downgrade (CenturyLink’s and all its subsidiaries’ debt). At this time, CenturyLink’s senior unsecured debt is rated Baa3 by Moody’s. A downgrade would take the company’s debt from investment grade to non-investment grade status. S&P has already assigned a non-investment grade rating, BB, to CenturyLink’s debt.
In February 2012, I wrote a two-part series on the top 10 highest yielding split-rated bonds with less than 10 years to maturity. I defined split-rated as debt with one investment grade rating and one non-investment grade rating from Moody’s and S&P. In Part II, a reader asked me why he/she should buy the bond when the stock was yielding roughly 7.6%. Since that time, the stock is down a bit more than 13%. The dividend yield, using the closing price of CenturyLink’s stock on the last trading day before my article was published, would now be 5.68% as a result of the recent dividend cut. That type of question and reasoning is something I have seen and heard on multiple occasions, whether it be through the financial media or in casual conversations about the financial markets. I have come to expect that the majority of investors who favor equities over bonds will operate under assumptions about the future that sometimes do not include the possibility for dividend cuts or long-term share depreciation.
If you have done your homework on the company and are interested in investing in CenturyLink, but you prefer to avoid the volatility of the stock, here are several CenturyLink bonds that are trading on the secondary market:
CUSIP 156700AT3, 3/15/2042 maturity, 7.65% coupon, asking 98.25 cents on the dollar, 7.802% YTM.
CUSIP 156700AM8, 9/15/2039 maturity, 7.60% coupon, asking 97.813 cents on the dollar, 7.795% YTM.
CUSIP 156700AS5, 3/15/2022 maturity, 5.80% coupon, asking 101.177 cents on the dollar, 5.632% YTM.
CUSIP 156700AR7, 6/15/2021 maturity, 6.45% coupon, asking 106.20 cents on the dollar, 5.509% YTM.
CUSIP 156700AN6, 9/15/2019 maturity, 6.15% coupon, asking 108.584 cents on the dollar, 4.619% YTM.
CUSIP 156700AQ9, 6/15/2017 maturity, 5.15% coupon, asking 106.679 cents on the dollar, 3.469% YTM.
If you are interested in purchasing CenturyLink bonds, keep in mind that make whole calls, which the aforementioned bonds have, allow a company to redeem the bonds early—at a time of the company’s choosing. Additionally, keep in mind that the Moody’s press release, mentioned above, states the following:
“Assuming the company maintains leverage comfortably below its new goal of less than 3.0x Debt to EBITDA, unadjusted (equal to about 3.5x, Moody’s adjusted) and manages its share repurchases in a manner that does not place undue stress on its liquidity, we would expect to assign a Corporate Family Rating that is one notch lower than CenturyLink’s Baa3 senior unsecured rating.”
This language, in my opinion, implies a significant likelihood of at least a one-notch downgrade of the senior unsecured debt. Fitch recently joined S&P in assigning a non-investment grade rating to CenturyLink’s senior unsecured debt (Fitch at BB+), and Moody’s looks like it will join its competitors in doing the same. With that said, the market appears to be well ahead of the rating agencies, pricing CenturyLink’s debt as if it were at best a Ba3/BB- credit, if not a single-B credit. As part of a broader look into the company’s fundamentals, potential investors should therefore rely less on the specific rating assigned to CenturyLink and instead focus more on the language used in the rating agencies’ press releases. The language often subtly tells a different story than the rating itself does.
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