Dividend Analysis of Communication Equipment Stocks

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Jun 25, 2014

For this article I've researched dividend paying companies in the Communication EquipmentIndustry. Also, to make sure I find the best companies, all three stocks mentioned in this articlecomply with the following criteria:

  • Market cap of more than $500 million and an average volume of at least 300,000 for lowvolatility.
  • Cash per share and current ratio greater than one, meaning good liquidity and dividendsustainability.
  • Price to sales of less than one, meaning a fair trade-off between the cost and sales.
  • DCF valuation discount of at least 20%, meaning that earnings translate into cash flow.
  • Dividend yield of at least 3%.

Tellabs (TLAB, Financial)

The company develops telecommunication networking products for communication service providers internationally. It has $2.25 per share in cash and short-term investments, and a current ratio of more than 2.5. Also analysts expect $0.13 in EPS for the next fiscal year, and thecurrent stock price is 17 times that figure, compared to its peer average of 34 times, suggestingTellabs still remains undervalued when compared to its industry and competitors.

Though Tellabs has historically managed high single-digits EBITDA margins, I don't think the company will manage that again until 2015/2016 as the company reviews its current strategy, product portfolio and cost structure.

Currently, the company has similar margins on EBITDA and operating cash flow in the low-to-mid single-digits and its enterprise value implied by the current stock price is 14.5 times trailingEBITDA. Tellabs generated $41 million in cash from operations in the fourth quarter -- through better collection of its accounts receivables.

It distributed $7.4 million through regular quarterly cashdividend and $367.6 million through a one-time special dividend of $1 per share. The company is yet to announce a dividend. The share count has already fallen from 400 million in fiscal 2008 to 368 million at the end of 2012, and considering the management's plans on buybacks, this trend should continue.

All told, I'm comfortable with a long-term revenue growth outlook of low single-digits on Tellabs -- excluding fiscal year 2013. I expect the company to grow its free cash flow at a 3%-5% rate forthe long-term. Discounting that back, it suggests a fair value of about $3.

Exelis (XLS, Financial)

The company provides intelligence, surveillance, and reconnaissance related products and systems internationally. It has $1.55 per share in cash, and a current ratio of more than 1.4. Also, analysts expect $1.52 in EPS for the next fiscal year, and the current stock price is 7.3 times thatfigure, compared to its peer average of 34 times, suggesting Exelis is significantly undervaluedwhen compared to its industry and competitors.

It has EBITDA margins in the mid-teens and operating cash flow margin in the high single-digits.The company's enterprise value implied by the current stock price is only 3.45 times trailingEBITDA, much lower than the rest of the industry.

In 2012, it generated free cash flow of $285 million -- even after $266 million in contributions made by the company to its pension fund. Backed by this strong free cash flow, the companyshould be able to further increase its cash reserve by more than a dollar per share next year. The company also declared a cash dividend of $0.1033 per share for the first quarter.

Long-term sales growth is where the estimates get tricky. The company faces revenue declines from defense spending cuts due to the rising focus on deficit reduction. Nevertheless, I expect a steady improvement in free cash flow generation. All told, I think Exelis can grow its free cash flow in the low single-digits rate for the long-term. Discounting that back, it suggests a fair value of about $15.

Harris Corporation (HRS, Financial)

Harris is an international communications and information technology company serving government and commercial markets in more than 125 countries. It has $2.91 per share in cash,and a current ratio of more than 1.9. Also analysts expect $5.06 in EPS for the next fiscal year,and the current stock price is 9 times that figure, compared to its peer average of 34 times.

It has an impressive EBITDA margin in the low-20s and an operating cash flow margin in thehigh-teens. The company's enterprise value implied by the current stock price is only 6 timestrailing EBITDA. With a free cash flow margin in the mid-teens, the company should producemore than $5 per share in cash next year.

The company recently declared a quarterly cash dividend of 37 cents per share on its common stock. Also, it completed the previously announced sale of its broadcast communications business to an affiliate of The Gores Group for $225 million. This will help the company's strategy to optimize its business portfolio and focus on its core businesses.

The company also has been spending a significant portion of its operating cash flow on stock buybacks. Consequently, the share count has already fallen from 135 million in fiscal 2008 to 114 million at the end of 2012.

All told, I'm comfortable with a long-term revenue growth outlook of low single-digits on Harris Corp. But due to low CAPEX margin, this would speak to long-term free cash flow growth potential of at least in the mid-to-high single-digits. Discounting that back, it suggests a fair valueof about $62.

Conclusion

Most investors prefer companies that pay dividends. But to generate safe and stable income in a volatile market environment, investors should diversify their portfolio with different industries.With impressive cash flows and dividend yields of more than 3%, the aforementioned stocks in the Communication Equipment Industry should definitely be a part of your dividend portfolio.