Rising Interest Rates Could Help This High-Yield Dividend Stock

With roughly $30 billion of debt, including almost $10 billion of floating-rate debt, Lumen Technologies (NYSE: LUMN) might seem like a bad investment in a period of rising interest rates. Investors certainly seem worried. Lumen stock has lost a quarter of its value over the past year. That has lifted this dividend stock’s yield to a sky-high 9.6%.

Yet rising interest rates could actually aid Lumen’s efforts to reduce its debt load following a pair of pending asset sales. That could pave the way for big share price gains as the telecom company’s growth investments start to pay off in the next few years.

Interest rates are rocketing higher

When the pandemic hit the U.S. in 2020, the Federal Reserve acted aggressively to support the economy. It cut short-term interest rates to near zero. The Fed also used bond purchases to push down long-term interest rates. As recently as last summer, short-term government debt yielded less than 0.1%, while even the 10-year Treasury had a minimal yield of around 1.3%.

More recently, surging inflation has forced the Fed to shift gears. Rather than trying to support the economy, the Fed is now focusing on tamping down inflation by raising interest rates. The federal funds rate has surpassed 1.5%, while 10-year Treasuries currently yield over 3.2%. The Fed anticipates lifting its short-term interest rate target to around 3.4% by year-end.

U.S. federal funds rate and 10-year government bond interest rate, Data by YCharts.

Interest rate increases immediately hit companies with floating-rate debt (like Lumen) with higher interest costs. It is also becoming more expensive to refinance fixed-rate debt when it matures.

Asset-sale proceeds on the way

Ordinarily, rising rates would be bad for Lumen. But the company expects to close two major asset sales in the second half of 2022. That will provide a big influx of cash that it can use for debt repayments.

First, Lumen is selling its Latin American operations for $2.7 billion. It currently expects that deal to close in the third quarter, perhaps as early as July 1. Second, Lumen is selling its traditional telecom operations in 20 states to affiliates of Apollo Global for $7.5 billion. It anticipates closing that deal later this year.

Apollo will assume $1.4 billion of high-cost debt from Lumen as part of its asset purchase. In addition, the two deals should generate at least $7 billion of discretionary proceeds combined, after factoring in deal-related taxes and purchase adjustments.

Lumen will use most of this cash to pay down debt. The recent jump in interest rates will help it get more bang for its buck.

Debt reduction coming soon

When interest rates were low, much of Lumen’s long-term debt traded above face value. That meant Lumen would have had to pay a premium to redeem it ahead of schedule. By contrast, much of the company’s debt now trades at a discount to fair value.

For example, Lumen has about $1 billion of corporate debt due in 2039 and 2042. Last summer, that debt traded at a roughly 15% premium to par. Today, it trades at a nearly 20% discount. Lumen also has $2 billion of debt maturing in 2029 that trades at an even greater discount to par.

At current market prices, Lumen could potentially use $7 billion of asset sale proceeds to retire about $8 billion of its fixed-rate debt through tender offers. Including the benefit of transferring $1.4 billion of high-cost debt to Apollo, this would reduce annual interest expense by around $550 million. That would more than offset the increased interest expense for its floating-rate debt.

A dividend stock worth a look

So far, turbulent market conditions don’t appear to have derailed either of Lumen’s planned asset sales. Assuming both deals are completed as scheduled, Lumen could potentially reduce its debt to around $20 billion by year-end.

Image source: Getty Images.

The main risk for shareholders is that the company’s recent trend of declining revenue continues indefinitely. However, Lumen’s upcoming asset sales will improve its revenue mix toward higher-growth businesses. And it plans to invest billions of dollars over the next several years to expand its fiber network to homes and small businesses, positioning it for strong broadband revenue growth. It has also made promising investments in edge computing and security.

If these investments pay off as planned, Lumen should return to growth in 2024. A return to revenue growth — together with a reduced debt load — could propel shares of this dividend stock significantly higher. In the meantime, shareholders can sit back and enjoy the generous 9.6% dividend yield.

Adam Levine-Weinberg owns shares of Lumen Technologies. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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