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Stock Analyst Update

Why We're Lukewarm on CenturyLink's Business

Revenue growth remains elusive for the no-moat firm.

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We continue to think  CenturyLink (CTL) is benefiting from low investor expectations and that Wall Street is content as long as the firm maintains its dividend and avoids any indication that its business is spiraling. CenturyLink's second quarter met that threshold and even offered an upside revision to 2018 profit guidance, now pointing to adjusted EBITDA of $9 billion-$9.15 billion, up about $200 million from the previous outlook. We don't read much into the revision longer term, as it seems CenturyLink has simply accelerated synergy recognition that we were already forecasting, but it provides reassurance that the firm is reaping the benefits from the Level 3 acquisition, which our outlook depends on. We have been lukewarm on CenturyLink's business, as we think it faces challenges in both its consumer and business segments and lacks a clear competitive advantage, hence our no-moat rating. However, our forecast reflects these challenges, and nonetheless we see the stock as mildly undervalued compared with the $22 fair value estimate we are maintaining.

Finding sales growth remains the challenge for CenturyLink. Revenue of $5.9 billion in the quarter fell a bit shy of consensus estimates and was down 2% on a pro forma basis. Management is painting recent weakness as the result of a transforming business and has indicated that it is proactively moving away from low- or no-profit revenue--some of which consists of larger contracts--and is instead focusing on profitable revenue. We suspect low-profit revenue is a more pervasive challenge in the consumer segment, and we forecast revenue declines there each year of our five-year forecast. We expect business segment revenue to return to growth in 2019 and average about 1% annually through 2022. Overall, we see our long-term projections as consistent with management's narrative--we expect less than 1% annual consolidated revenue growth over the next five years but see EBITDA margin expansion to 39% in 2022, from 35% in 2017.

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Matthew Dolgin does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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