Shares of Lumen Technologies (NYSE:LUMN) rose 39.4% in the first half of 2021, according to data from S&P Global Market Intelligence. The telecom company rose from a very low valuation coming into the year. Like many other value stocks in 2021, Lumen seemed to benefit from sentiment around the economic recovery coming out of the COVID-19 crisis.
From an operating perspective, in the first half, Lumen continued to post revenue declines, which has contributed to low sentiment and a bargain-basement valuation. Yet the company also wrung more profits out of each dollar, expanding profit margins, and there were even some green shoots in certain segments of Lumen’s results. That may have garnered optimism for management’s turnaround plan.
Lumen is repositioning itself from a copper-based telecom with a large business in landline phones to one with an emphasis on fiber-based communications and edge computing, data centers, content delivery and security markets. While Lumen doesn’t participate in a big way across all of those segments, these markets are slated to grow at a 14% average growth rate through 2024.
Despite the targeting these high-growth segments, Lumen’s revenue still fell in the first quarter by 3.8% — slightly worse than analysts predicted, as its legacy businesses continued to weigh on results. And yet, there were some silver linings: Adjusted EBITDA margins continued to expand to 43.1%, up from 42.3% in the year-ago quarter. Lumen’s fiber infrastructure services also grew across both enterprise and wholesale markets, and the newly branded Quantum fiber consumer broadband grew revenue as well. However, these high-profit segments still make up a relative minority of Lumen’s revenue base.
It remains to be seen whether Lumen can successfully transition to more new-age services — hence why the stock trades so cheaply. Management expects $2.8 billion to $3 billion in free cash flow this year. At a market cap of just $14.6 billion, the stock trades at a multiple of just five times cash flow at the midpoint. That cheap valuation enables the company’s 7.5% dividend to be covered nearly three times over by cash flow.
Of course, Lumen also has a high debt load around $31.3 billion as of last quarter; however, Lumen has also been paying that debt down gradually over the past few years, and has also been able to take advantage of the current low-rate environment to refinance higher-rate notes.
Lumen is not likely to be a millionaire-maker growth stock anytime soon, and Wall Street is right to be somewhat skeptical; however, if the company continues to make incremental progress in its business transformation, the stock has the potential to rerate much higher, even after its good first half.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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