Big telcos like AT&T (T) and Verizon (VZ) usually come to mind first when thinking about high yield in this sector. However, dividend investing doesn’t always have to be a popularity contest, as it sometimes is The best value for money can be found in underappreciated income stocks that have great potential.
Which brings me to Cogent Communications (NASDAQ:CCOI), an emerging player trading well below its 52-week high of $79. This article shows why income growth investors should take a close look at this dividend payer, so let’s get started.
Cogent Communications is a telecommunications provider to enterprise customers in Tier 1 facilities, many of which are high-rise buildings in North America, with services such as high-speed Internet, Ethernet transport and colocation services. Its all-optical IP network backbone provides services in 219 different markets. In the last 12 months, CCOI generated total revenues of $579 million.
What sets CCOI apart from its major telecom competitors is that it leases fiber rather than large amounts of capital to provide fiber, giving it more financial flexibility and helping it avoid some of the oversupply problems that have plagued some markets. The benefits of this competitive differentiation are highlighted by Morningstar in its latest analyst report:
Cogent’s advantages stem from its leased, low-cost, Internet-specific network and the opportunistic purchases it made to build its network. Rather than building a network itself by burying fiber optics, which we find often doesn’t justify the high cost due to oversupply in many regions, Cogent signed long-term leases to acquire the rights. We believe the company is paying below market prices because it added large portions of its network during the industry downturn and before technology enabled so much capacity on fiber strands.
Cogent’s network is connected to more than 1,800 high-rise buildings in North America. It only serves corporate customers in those buildings, as its model is not viable in less densely populated areas. Businesses typically seek connectivity for both Internet services and private networks. Private networks have evolved significantly in recent years as businesses can use internet-based, virtual solutions instead of more expensive legacy products.
Combined with a network architecture optimized for the Internet and a lack of legacy products to support, it is superior to most of its competitors, which include large telecommunications companies.
Meanwhile, CCOI continues to post respectable growth, with third-quarter service revenue growing 4.7% on a constant currency basis. Additionally, CCOI becomes a more efficient company, with EBITDA margin up 90 basis points year over year excluding the impact of the $2 million acquisition of Sprint (T-Mobile Wireline).
Given Cogent’s focus on enterprise connectivity, going back to the office poses a near-term risk as many employees continue to work from home, although many employers have recently attempted to encourage their employees to return to the office. Recent trends show that return to work is developing positively, albeit slowly. Also encouraging is that management also expects to realize cost savings across the network, driven by the following actions, as noted during the recent conference call:
Over the next three years, we project annual savings of $180 million across the North American network, primarily through the use of Cogent’s subway space and our On-Net building portfolio. We also estimate annual savings of $25 million on the international network by migrating from a leased network to Cogent’s own network globally.
In particular, management seems to appreciate the importance of the dividend to shareholders. This is reflected in the fact that CCOI has increased its dividend for 41 consecutive quarters, including the most recent 1% increase to $0.915 per quarter. This also represents an impressive 10% year-over-year increase. Looking ahead, management expects annualized dividend growth in the mid-range of 4%, which is in line with its current free cash flow growth rate.
Finally, I find CCOI attractive at the current price of $57.77 with a price to cash flow ratio of 15.6, which is at the low end of the mostly 15-27x range over the past 5 years.
Morningstar has a fair value estimate of $65 and analysts have a consensus buy rating with an average price target of $63, for a potential one-year total return of 15% including the dividend. Over the long term, CCOI could generate an 11% annualized total return, considering the 6.3% dividend yield combined with the ~4.5% annual dividend growth that management expects.
In summary, Cogent Communications is a largely underwatch stock that occupies a unique niche in the telecoms industry. The business model of leasing network services and connecting enterprise customers has proven resilient in a volatile macro environment. With an impressive initial yield of 6.3%, 41 consecutive quarters of dividend increases, and expectations of mid-4% annual dividend growth going forward, the stock is attractive to income investors.