The Oxen Group Initiates Coverage of Frontier Communications at Buy with Price Target at $16

 

The company at its current valuation is undervalued by a significant amount. The company is in the landline industry, which is not a growing industry. Yet, the landline is still very important to businesses, homes, and rural areas. The landline industry is continuing to lose its market share to wireless, and there is a significant shift for homes to have only wireless service. Therefore, the pie is shrinking in which Frontier operates, but the company does have the largest pie.

 

The company, over the next couple years, should see its operating income grow as it incorporates and expands based on the Verizon acquisition. However, the company is losing more subscribers than they are gaining, which does cause one to become quite cautious of the company. On a five year outlook, landlines will still be an important industry that will not lose such significant subscribership that companies will become obsolete.

 

One of the best aspects of Frontier Communications is that it operates in the rural side of the industry. While wireless companies continue to move into these areas, there is much less drop off in landlines in the rural populations than in urban ones. Still, in its last quarter the company saw its losses quadruple its new subscribers. The company has been able to help itself by lowering costs, and it has increased its operating margins. Additionally, the company will significantly increase its earnings with the addition of Verizon’s lines. This addition will allow for the company to increase its book value, P/E value, and challenge its current price levels.

 

Additionally, the company offers a very significant dividend with a yield over 9%. The company’s yield is the highest on the S&P 500. It is currently $0.75 per share, which was recently cut from $1.00. The high yield has been criticized by many, andanalysts believe that it cannot last since the dividend per share is higher than the earnings per share. Yet, the company is still offering a significant yield. Even a decrease would still mean a high yield. It is a nice way to continue to make money off a company that has lacked growth as of recently.

 

Another promising sign from the company is that its management has been doing a solid job of running the company from the standpoint of an investor’s frame of mind. Company CEO Meredith Wilderotter owns $14 million worth of Frontier Communications, which is about 0.2% of the shares outstanding. This is a bit lower than what investors want to see because it means that the executives do not have as significant of a holding. Despite this snag, the company has exceptional return on equity that continues to grow each year. The company is cutting costs and managing its assets very well. This is also a good sign that the company will be able to successfully manage its incoming Verizon assets. Another great sign from the company is that it has been able to increase revenue per employee over the past five years as well, rising from $330 to $392 million in past five years.

 

The financial side of Frontier Communications proves to showcase more positives for the company. The company seems to be pretty financially healthy. They currently have a 1.8 current ratio, which is above the 1.5 minimum for financial health. This ratio is just below Windstrem at 2.1, but it significantly above Qwest and CenturyLink, which both are below 1. The company also has seen its operating margins increase over the past two and a half years to 30.2%, which is a very high operating margin that furthers showcases the company’s ability to manage costs and assets well.

 

One concerning statistic is that the company has a very high price to tangible book value, which is above 9. This compares to Windstream at 9 and CenturyLink at 1.25. Both Windstream and Frontier have very low book value per share. CenturyLink and Qwest have definitely been strides behind Windstream and Frontier, which may be the reason for such a discrepancy between the two groups. The book value will need to improve for Frontier to see significant growth, which means that stockholder equity needs to improve.

 

The company’s P/E ratio is at 19.43, which is slightly higher than the industry average at 15.4. Yet, the company is the leader in the industry now, and it is acceptable that its P/E ratio is a bit larger. The company has seen very strong free cash flow over the past five years. The company has a FCF margin at 20.5%, which is well above the 10-12% healthy range. The company is expected to see a lot more FCF coming through as it merges the new Verizon customers into their cash flow statement. The company’s FCF-Price ratio is above the industry standard, which is a very solid point as well.

 

Another positive financial aspect of the company is that it has rising ROIC over the past five years. ROIC is return on invested capital. A rising ROIC is a company that is slated to deliver more positive earnings in the future. A company with a falling ROIC is one that means it is not being able to make as good of returns on capital any longer, and it is likely to deliver less return per share. The company’s ROIC may be at risk as it attempts to make the transition with Verizon, but if it is successful. It will be a great feat.

 

Frontier is a well run company as has been shown in this article. Yet, the company is in the process of being tested as it tries to transform its Verizon lines to Frontier standards. The company has definitely been able to expand with the introduction of the new lines, but whether the company is going to be able to successfully manage its growth is still to be seen. Additionally, the company is in a flailing industry. The risk is definitely high with this company, but if the company can maintain steady grwoth over the next five years, it is significantly undervalued.

 

 

The Oxen Group’s fair value estimate for Frontier is $16 per share based on a discounted cash-flow analysis. The company should see a large influx in operating income and FCF this year and into next year. The question is whether growth can be sustained for five year, and the company can manage its growth. The company has a WACC at 6.3.

 

The company is a buy below $13.50 and a sell above $15. Currently, the company, therefore is a Buy at its $8 share price. The company’s share price is well below its five year FV forecast.