Cogent Communications Stock: A Great 6.3% Telecom Yield (NASDAQ:CCOI)

Big telcos such as AT&T (T) and Verizon (VZ) generally first come to mind when one thinks of high yield in this sector. However, dividend investing doesn’t always have to be a popularity contest, as sometimes the best value can be found in underfollowed income stocks that have big potential.

This brings me to Cogent Communications (NASDAQ:CCOI), an up-and-coming player that’s trading well off its 52-week high of $79. This article highlights why income growth investors may want to give this dividend payer a hard look, so let’s get started.

Why CCOI?

Cogent Communications is a telecom catering to enterprise customers in Tier 1 facilities, many of which are high-rise buildings in North America, with services including high speed internet, Ethernet transport, and colocation services. Its all-optical IP network backbone provides services in 219 different markets. Over the trailing 12 months, CCOI generated $579 million in total revenue.

What differentiates CCOI from its big telecom peers is that instead of spending high amounts of capital on deploying fiber, it leases it instead, giving it more financial flexibility and helping it to avoid some of the oversupply issues that have plagued some markets. The benefits of this competitive differentiation are highlighted by Morningstar in its recent analyst report:

Cogent’s advantages arise from its leased, low cost, internet-specific network and the opportunistic buying it did to form its network. Rather than building a network itself by putting fiber into the ground, which we think often fails to justify the steep expense due to oversupply over many geographies, Cogent has signed long-term leases to procure the rights. We believe the firm is paying below-market rates because it added major portions of its network during times of industry distress and before technology allowed so much capacity on fiber strands.

Cogent’s network connects to more than 1,800 high-rise buildings in North America. It serves enterprise customers in those buildings only, as its model is not profitable in less dense areas. Enterprises typically seek connections for both Internet service and private networks. Private networks have evolved significantly in recent years, as firms can use Internet-based, virtual solutions rather than more expensive legacy products.

When combined with a network architecture that was optimized for the Internet and a lack of legacy products to support, it is in a superior position to most competitors, which include major telecom companies.

Meanwhile, CCOI continues to demonstrate respectable growth, with service revenue growing by 4.7% YoY on a constant currency basis during the third quarter. Moreover, CCOI is becoming a more efficient enterprise, with EBITDA margin, excluding the impact of the $2 million of Sprint (T-Mobile wireline) acquisition increasing by 90 basis points YoY.

Given Cogent’s focus on enterprise connectivity, return to the office poses as a near-term risk, as many employees continue to work from home despite a recent push by many employers to encourage their workers to come back to the office. Recent trends show that return-to-work is trending positive, albeit at a slow pace. Also encouraging, management also expects to realize cost savings across its network, driven by the following actions, as noted during the recent conference call:

Over the next three years, we anticipate annualized savings of $180 million on the North American network, primarily by utilizing the Cogent metro footprint and our on-net building portfolio. We also anticipate $25 million of annual savings on the international network by migrating off of a lease network on to the owned Cogent network globally.

Notably, management seems to value the importance of the dividend to shareholders. This is reflected by the fact that CCOI has increased its dividend for 41 consecutive quarters, including the recent 1% increase to $0.915 per quarter. This also equates to an impressive 10% rise on a YoY basis. Looking forward, management expects annualized dividend growth in the mid-4% range, which is in line with its current free cash flow growth rate.

Lastly, I find CCOI to be attractive at the current price of $57.77 with a price to cash flow ratio of 15.6, sitting 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, equating to a potential one-year 15% total return including the dividend. Over the long-term, CCOI could generate 11% annual total returns, considering the 6.3% dividend yield combined with the ~4.5% annual dividend growth that management expects to see.

Investor Takeaway

In summary, Cogent Communications is a largely under-followed stock that has a unique niche in the telecommunications industry. Its business model of leasing network services and connecting enterprise customers has proven to be resilient amidst a volatile macroeconomic backdrop. With an impressive 6.3% starting yield, 41 consecutive quarters of dividend increases and expectations for mid-4% annualized dividend growth going forward, the stock is attractive for income investors.