Lumen Technologies, Inc. (LUMN) reported adjusted earnings per share of 48 cents on Feb. 10 for the fourth quarter of 2020, beating the consensus estimate of 30 cents per share. Revenue, however, landed in line with analyst expectations, and the stock has dipped more than 6% since the latest earnings release. With over 450,000 fiber route miles in North America and Europe, Lumen is one of the largest fiber network owners in the world.
Macroeconomic challenges faced by the broadband business segment have a lot to do with the 61% share price decline witnessed over the last five years. The good news, however, is that Lumen is now focused on catering to enterprise customers, positioning it as one of the key infrastructure players amid the ongoing rollout of 5G technology.
Lumen’s turnaround story is likely to be a success, and the stock seems significantly undervalued at the current market price of around $11.71.
Mixed Outlook but Lumen is on the Right Track
Lumen’s traditional enterprise and consumer businesses are facing headwinds as technological developments have increased the efficiency of network usage, resulting in reduced demand for the company’s fiber network. Enterprise businesses account for approximately 75% of the company’s revenue, but many U.S. companies are increasingly embracing shared networking services, leading to a decline in demand for private networks, which has also weighed on Lumen’s revenue.
In addition, the consumer business segment has come under pressure as the company continues to lose broadband subscribers with speed limits below 20 Mbps, which was one of its primary drivers of earnings in the past.
The good news is that Lumen has reshaped its business model to cater to leading national telecommunication giants such as AT&T Inc. (T) and Verizon Communications Inc. (VZ). Due to the extremely high capacity required to roll out 5G technology on a national scale, mobile carriers are depending on fiber networks, and Lumen is monetizing its expansive fiber network by catering to the largest mobile carriers in the United States.
The company is trying to mitigate the negative impact of macroeconomic headwinds by making the necessary changes to its business model, and the results are promising. Despite a 7% year-over-year decline in revenue, Lumen reported an increase in adjusted EBITDA margin from 42.3% in 2019 to 42.9% in 2020, highlighting the favorable mix in revenue and the success of its cost-cutting initiatives.
The company launched a plan in 2019 to reduce operating costs by $800 million to $1 billion by the end of 2021, and in 2020 alone, Lumen reported savings of $830 million, indicating that its efficiency has significantly improved.
The Valuation is Attractive
The market is pricing in a significant decline in corporate earnings for Lumen, and this has created an anomaly that could be exploited by value investors. The stock is trading at a forward earnings multiple of just 7.85, compared to the sector average of 22.27, suggesting the market is very bearish on the company’s prospects.
The change in business tactics, however, is likely to help Lumen Technologies improve its cash flow profile, even after taking a small hit on earnings. This will likely lead to stellar returns in the coming years as most of the savings will be passed on to shareholders via dividends and buybacks.
Solid Dividend
Lumen Technologies pays a quarterly dividend of 25 cents, and the annual payout of $1 per share translates to a dividend yield of 2.1% at the current market price.
The company reduced its quarterly dividend in early 2019 in a bid to save much needed cash, which was a bold but necessary decision to secure the sustainability of long-term earnings. According to company guidance, there will not be a dividend increase in 2021, so the company expects to pay out a total of $1.1 billion to shareholders this year.
Lumen generated $2.98 billion in free cash flows for 2020 and expects to generate between $2.8 to $3 billion this year, so the company should be in a strong position to cover dividend payments from the internally generated cash.
Wall Street’s Take
Wall Street has an average analyst price target of $12.03 for Lumen Technologies shares, which implies an upside potential of close to 3% from the current market price. In addition, the stock’s Hold consensus rating breaks down into 1 Buy, 2 Holds and 2 Sells.
This might not be a very high return, but Lumen Technologies is in the middle of a transformational phase, which could pave the way for very high returns in the coming years. (See Lumen Technologies stock analysis on TipRanks)
Takeaway
Investing in turnaround companies is a high-risk strategy, and due diligence plays a key role in helping investors identify companies that are likely to make it big as a result of a change in business tactics or improving macroeconomic conditions.
Lumen Technologies is facing macroeconomic headwinds, but tactical changes to the business model are helping the company negate the impact. Lumen might not be a good pick for growth-oriented investors, but the stock seems to be significantly undervalued, presenting value investors with a good opportunity.
Disclosure: The author is long Lumen Technologies shares.
Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.
