The communications company formerly known as CenturyLink rebranded itself as Lumen Technologies (NYSE:LUMN) in mid-September. The name change was meant to reflect the company’s focus on providing high-quality fiber data connections, an area with significant long-term growth potential. By contrast, the CenturyLink name is more associated with traditional copper phone lines and low-speed DSL internet.
Even a new name wasn’t able to break shares out of their long-term downward trend, though. Lumen stock has fallen significantly since the rebranding announcement and trades near multidecade lows.
Notwithstanding investors’ skepticism, Lumen’s transformation plan remains on track, as seen in the company’s solid third-quarter results. Meanwhile, the company has continued its aggressive efforts to pay down and refinance debt to bolster its balance sheet and reduce interest costs.
Moderating revenue declines and strong profitability
Lumen Technologies generated $5.17 billion of revenue in the third quarter, down 3.4% year over year and down just 0.5% sequentially. Revenue has been falling for a while, as customers drop legacy services like voice connections and low-speed DSL. In some cases, Lumen has also walked away from low-margin business, hurting its top line. In the short term, the pandemic has disrupted efforts to sell new products to small and medium-size businesses that are either struggling, not fully open, or working remotely. Lockdowns abroad have also weighed on its international business.
On the bright side, revenue for Lumen’s enterprise segment ticked up 0.8% year over year last quarter. And while consumer revenue fell 4.1% due to declining voice revenue, consumer broadband revenue rose 1.7% year over year, with a mix shift toward high-speed fiber connections more than offsetting customer losses for low-speed DSL services.
Meanwhile, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), excluding special items and transformation costs, stayed strong at $2.19 billion. That was up sequentially and down just 3.1% from the prior-year period. Lumen’s adjusted EBITDA margin increased slightly year over year, reflecting the success of its multiyear cost-cutting program. The strong margin performance was particularly impressive because the company incurred unusual expenses related to the pandemic and its rebranding during Q3.
Finally, adjusted earnings per share jumped 29% year over year to $0.40 in the third quarter. This easily beat the average analyst estimate of $0.30.
Deleveraging keeps paying off
Falling interest expense was a big driver of Lumen’s strong third-quarter earnings growth. Reported interest expense fell to $409 million last quarter from $496 million in the prior-year period.
The company continued its efforts to pay down debt and reduce its interest expense last quarter. In early August, it redeemed $300 million of high-cost debt. Also in August, it issued $840 million of new debt at a 3.625% interest rate, which it used to redeem a comparable amount of higher-cost debt. It redeemed another $250 million of high-cost debt in September. Together, these moves will reduce annual interest expense by about $50 million.
For now, Lumen plans to continue devoting the majority of its free cash flow (which has been averaging around $3 billion annually) to debt reduction. The company has nearly $4 billion of maturities between now and the end of 2022. Between repaying these scheduled maturities and ongoing refinancing moves, it should be able to cut annual interest expense to as little as $1.2 billion by 2023, down from $2.2 billion in 2018. That will provide a big earnings lift over the next few years.
Lumen stock is way too cheap
During a presentation earlier this year, executives noted that fiber assets tend to trade at very high valuations relative to legacy copper-based telecom businesses like the CenturyLink of five years ago. While Lumen gets a substantial and growing percentage of its revenue from its fiber assets, the entire company continues to trade like a legacy telecom.
Management argued that the stock would be worth about three times its current price (or between $24 and $35) if it were instead valued as a mix of legacy and fiber businesses. Given the stock’s sluggish performance, it’s clear that investors weren’t convinced.
But as fiber-based services become a bigger part of the revenue mix and the pandemic recedes over the next few years, Lumen’s top line should stabilize and then return to growth. Meanwhile, cost cuts and plunging interest expense will boost earnings. The company’s deleveraging efforts will also reduce risk, making investors less nervous about Lumen stock.
Together, these factors could finally unlock the share price upside that management envisions over the next two to four years. In the meantime, investors are getting paid to wait, thanks to Lumen’s handsome 10.8% dividend yield.