Straight away when we look at the long-term technical chart of CenturyLink (CTL), we can see that a bullish divergence is forming on the RSI indicator. A bullish divergence takes place when the technical indicator essentially trades in the opposite direction to price. Price in essence prints a lower low but the RI prints a higher low. This means the momentum is being lost to the downside, which invariably means that price usually forms a strong bottom soon thereafter. As the chart shows below, we actually had the same conditions back in 2008 when we also witnessed a bullish divergence in the RSI momentum indicator. Therefore, if history repeats (and it usually does unless the fundamentals have not been badly impaired), we should be at the start of a long-term trending move here in shares of CTL.
From a valuation standpoint, the present earnings multiple of 8.8 will stick out like a beacon, especially when compared to the telecom services industry as such. However, the valuation multiple which we want to hone in on in this article is the stock’s cash-flow multiple which presently comes in at ultra-low 1.61. Many value investors favour the earnings, sales and book multiples when evaluating potential value plays. However, in environments such as we have at present and more so in the telecommunications industry where debt is much higher than the norm, a low cash-flow multiple brings added safety to the equation. Let’s explain.
Many value investors bemoan a below-average dividend yield for example, especially when companies report very low pay-out ratios. Low pay-out ratios usually mean that a company can pay out far more of its cash flows to its investors but is declining to do so for some reason. With respect to CTL, for example, income-orientated investors cannot be too dissatisfied here. Despite the recent dividend cut, the yield is still well over 10% at present when calculated off the present share price. In fact, even with the annual pay-out coming in at $1 per share annually, the pay-out ratio when calculated off free cash flow comes in at a very healthy 35%. Suffice it to say, no problem with affordability here.
If we go one step further and calculate the distribution off operating cash flow, the pay-out ratio would come in at a mere 16%. While we like this large cash buffer which is clearly evident at present, some investors may say that not enough cash is being put to work.
However, if there was ever a time to invest in stocks with strong cash-flow positions, the time has to be now. For example, as investors, we always need to be thinking about the worst-case scenario. If the economy was to take a significant downturn, for example, firms which are heavily leveraged would have to raise cash somehow in order to compensate for the lower earnings take. Raising cash can be achieved by
- Selling assets
- Diluting shares
- Increasing debt
Firms with plenty of cash flow have that buffer, which means they can withstand violent downturns better than most.
If we go to the daily chart, we can see that we can draw an upward sloping trend line due to price having consistently made higher lows since March of this year. The 10-day moving average is vital here. We need price to trade above this support level once more with conviction to keep the bullish pattern going. Any breach of the drawn trend line below could easily mean the March lows will be tested in the near term. Therefore, our cue (in order to put more long deltas to work than short) will be to wait for that 10-day moving average to turn up convincingly.
To sum up, CTL is a low-priced stock with plenty of cash flow at present. It has liquid options and implied volatility remains well above its 12-month range at present. Once we get a good read on short-term direction, we will tailor our trade-in here accordingly. Again, we will most certainly use options to control risk to the best of our ability. The long-term charts are demonstrating that the next major move should be upward. Let’s see if this plays out on the daily chart over the near term.
Elevation Code’s blueprint is simple. To relentlessly be on the hunt for attractive setups through value plays, swing plays or volatility plays. Trading a wide range of strategies gives us massive diversification, which is key. We started with $100k. The portfolio will not stop until it reaches $1 million.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source: Seeking Alpha