Merrill Lynch has chosen several stocks from several different sectors to upgrade on Monday. Both of the telecom companies under this broader sector upgrade and downgrade theme have had positive reactions around the news. The brokerage firm upgraded Windstream Holdings Inc. (NASDAQ: WIN) and Frontier Communications Corp. (NASDAQ: FTR) to Buy ratings from Neutral, with solid upside on top of the high payouts these companies give to their shareholders.
Along with the rating boost, Windstream’s price objective was set at $10. Merrill Lynch considers the company’s current valuation as attractive following the announced CEO change and the resulting stock sell-off.
Previously, Windstream shares have underperformed the S&P 500 by 12% amid concerns about the health of the core business and the trading risks surrounding the company’s proposed real estate investment trust (REIT) spin-off. The company’s current valuation is considered by the firm too inexpensive to ignore and it represents an opportunistic buying opportunity.
Merrill Lynch commented:
Due to its high yield and low growth profile, Windstream’s stock has historically attracted a large retail investor base. We estimate approximately 40% of the company’s float is currently owned by retail investors. At the time of the REIT spin-off announcement, the Windstream OpCo entity was structured as a low growth co. with a relatively low dividend yield (~2% we estimate). Following the REIT spin-off, the risk has been that few buyers would emerge for the REIT and many former income holders would sell the operating company due to its lower implied yield. Given the recent stock sell-off, however, the current stock price implies that both post-split entities will trade with substantial yields and trade at substantial valuation discounts to peers, mitigating this post-split ‘venue’ risk and instead creating an opportunity, in our view.
Ultimately, Merrill Lynch’s investment thesis was based on a high dividend yield that should act as a premium for higher-than-average risk related to the recent CEO change. Additionally, the firm believes that the stock price implies a steep discount compared to peer and historical valuations in anticipation of breaking into separate operating and REIT stock components.
Shares of Windstream were up 2.5% at $8.32 in the last three hours of trading Monday. The stock has a consensus analyst price target of $9.80 and a 52-week trading range of $7.18 to $13.30.
Merrill Lynch set a price objective of $7.50 on Frontier Communications. The upgrade is part of the firm’s sector “self-help” thesis for 2015. Frontier has shown the ability to generate broadband market share growth, which has the potential to accelerate on the back of potential frictions that emerge following the Comcast/Time Warner Cable merger close. The firm does not see any issues with the stability of Frontier’s dividend.
After the close of the AT&T Connecticut acquisition, the firm believes that Frontier has an opportunity to extract greater-than-guided synergies from the combination.
Previously, Frontier faced problems integrating the 2009 Verizon transaction, but since that time the company has digested many lessons and faces substantially less difficulty integrating a business that is directly adjacent to the business it already runs. In the firm’s opinion, the company will raise guidance with the conservative approach from the outset.
The $7.50 price objective assumes a 6.7-times multiple, based on 2015 EBITDA estimates, and the firm’s target puts Frontier’s annual dividend at $0.42, which is a 5.6% yield.
Shares of Frontier were up nearly 3% at $6.68 in the last three hours of trading. The stock has a consensus analyst price target of $6.25 and a 52-week trading range of $4.40 to $7.24.
Windstream’s most recent dividend would still be in the double-digit yield category, at least before considering the restructuring. Frontier’s most recent dividend generated a yield north of 6%.
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