Why Merrill Lynch Loves CenturyLink and Its High-Yield Dividend

Merrill Lynch reiterated a Buy rating for CenturyLink with a price objective of $42. This is based on CenturyLink’s revenue stability, which it has proved in the past year, along with other merits of its asset mix.

One of the big moves coming from CenturyLink is that the company is going to pay some of its 2015 tax bill in 2016. This would shift roughly a $300 million into the first half of 2016, resulting in the 2016 payout ratio appearing elevated.

This strategy will generate a lower 2015 dividend payout ratio and an abnormally higher 2016 payout, by design. Merrill Lynch believes some observers are either misconstruing or simply ignoring the present value of money benefits to this kind of management. The company is actively shifting this tax burden to 2016 and feels comfortable that it will have the cash to cover the dividend. If not, CenturyLink could just pay the tax bill in 2015 and have a more stable payout ratio over both years. Additionally, the firm has CenturyLink repurchasing about $760 million in shares in 2015, which would lower its total dividend by $40 million.

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CenturyLink is the nation’s third-largest telephone company and the largest rural exchange provider, serving residential, business and wholesale customers. It has 14 million access lines and 5.9 million high-speed Internet connections across 37 states.

While the Yahoo! Finance shows the yield at 6.3% and the Google Finance placed it at 6.25%, Merrill Lynch addresses its investment thesis, with assumed yields ahead, as follows:

We view yield-based wireline stocks as the equivalent of equity bonds, where the required return (yield) is a function of relative risk (FCF payout ratio). Within this framework, CenturyLink screens positively among yield stories with a 5.5% yield stemming from a 48% 2015E payout ratio. Our PO, which has an assumed yield of 5.1%, reflects the company’s improving top-line trajectory and better-than-average dividend coverage.

The stock was trading as high as $40 in February but has since retreated to the current price level under $35. Merrill Lynch sees this as a renewed concern about “dividend safety,” which the firm views as less applicable now than even a year ago.

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Just following the opening bell, shares of CenturyLink were up 1% at $34.42, in a 52-week trading range of $32.45 to $45.67. The stock has a consensus analyst price target of $39.31.