Crown Castle (CCI): A High Quality REIT With Healthy Dividend Growth Prospects

Crown Castle (CCI) only began paying dividends in 2014, but the company currently offers income investors a high dividend yield near 4% with 6-7% annual dividend growth potential.

 

Crown Castle also has an attractive business model with substantial recurring revenue, excellent free cash flow generation, and extremely high incremental margins.

 

Let’s take a closer look at Crown Castle’s business for consideration in our Top 20 Dividend Stocks portfolio.

 

Business Overview

Crown Castle began operating as a real estate investment trust (REIT) in 2014 and is the largest provider of shared wireless infrastructure in the country.

 

Crown Castle owns approximately 40,000 towers and 16,500 miles of fiber supporting small cell networks.

 

The company leases its towers out to wireless carriers, which need Crown Castle’s infrastructure to provide wireless services to consumers and businesses.

 

Tenants deploy communications equipment, coaxial cables, and antennas at the top of Crown Castle’s towers that transmit signals between the tower and mobile devices. Most towers have capacity for at least four tenants.

 

The big four wireless carriers account for 90% of Crown Castle’s revenue, and the company is completely focused on the U.S. wireless market, where over 70% of its towers are located in the top 100 largest markets.

 

Over 80% of the company’s revenue is recurring, and most of its site rental revenue results from long-term leases with initial 10-year terms and five-year renewal periods thereafter.

 

Business Analysis

Despite its customer concentration, Crown Castle’s business model is attractive for a number of reasons, beginning with its predictability.

 

The company has an average remaining customer contract term of six years and approximately $20 billion remaining in contracted lease payments (compared to $3 billion in 2015 site rental revenue), providing excellent cash flow visibility.

 

Crown Castle’s leases also have built-in price escalators, which are expected to continue adding around 3% to the company’s annual earnings growth.

 

In addition to annual rent escalators, tower economics are also attractive because very little cost is involved to add additional tenants.

 

A recent investor presentation by Crown Castle highlighted that the company enjoys a 96% incremental margin when it adds an additional tenant to one of its existing towers.

 

In other words, if a new tenant brings in $25,000 of additional rental revenue, Crown Castle keeps $24,000 in gross profits. The operating leverage in this business is tremendous, and substantially all of Crown Castle’s wireless infrastructure can accommodate additional tenancy.

 

As data growth continues accelerating, it seems reasonable that demand for Crown Castle’s wireless infrastructure will also rise over time.

 

Carriers have no substitutes for wireless infrastructure, which is mission-critical for their businesses to operate.

 

Additionally, by collocating on shared wireless infrastructure, wireless carriers only have to pay for their proportional usage of the infrastructure.

 

Instead of needing to occupy an entire company-owned tower themselves, carriers can rent only the space they need to enhance their network coverage and continue servicing their customers.

 

As a result of these factors, tenant leases have historically enjoyed a high renewal rate. Non-renewals have averaged just 2% of site renewal revenues over the last five years.

 

Many of Crown Castle’s towers are also located in areas with strict zoning restrictions and other regulations, limiting supply and making its infrastructure harder to replicate by new entrants.

 

Crown Castle’s cost structure is also fairly stable because the company maintains long-term control over the majority of land under its towers.

 

About one-third of Crown Castle’s site rental gross margin is generated from towers on land the company owns, and its current portfolio of ground leases have an average remaining term of about 31 years.

 

Importantly, over 75% of its site rental gross margin is from towers where the land is owned or controlled by company for at least 20 years. There is little risk of Crown Castle losing control of its real estate assets.

 

As a result of continuously growing demand for data and a portfolio of mission-critical wireless infrastructure, Crown Castle has delivered extremely reliable growth throughout numerous market cycles. In fact, the company’s rental revenue and gross income has increased every year since 2002.

 

The company also maintains an investment grade credit rating, which allows it to continue accessing capital on favorable terms to invest opportunistically in growth projects.

 

Overall, Crown Castle has a fundamentally strong business that seems to have a solid outlook for at least the next five years. The company possesses a number of the factors I look for to find safer stocks.

 

Crown Castle’s Key Risks

The biggest risks facing Crown Castle are customer concentration and evolving technological trends.

 

AT&T (30% of rental revenue), T-Mobile (22%), Sprint (19%), and Verizon (18%) account for about 90% of the company’s total revenue.

 

The U.S. wireless market is an oligopoly, so there’s really not much Crown Castle can do to diversify its customer base.

 

While the U.S. wireless market is relatively stable, Sprint faces financial difficulties and has been slashing spending to begin working down its substantial debt load. The company has lost money for seven straight years and is struggling as the smallest “major” carrier.

 

Will Sprint’s struggles impact Crown Castle? It’s hard to say. The company is likely too large to be acquired by one of the other major carriers due to anti-trust concerns, and it’s difficult to know if it would benefit from cutting back its business with Crown Castle – a lower quality network with less coverage isn’t exactly a winning strategy. Regardless, Sprint’s situation is certainly worth monitoring because the company faces legitimate financial challenges.

 

It goes without saying that the loss of any of Crown Castle’s major customers would be devastating. However, I think this risk has a very low probability.

 

Non-renewals are usually the result of mergers between carriers because they can consolidate their wireless infrastructure needs. Recent examples include AT&T, T-Mobile, and Sprint acquiring Leap Wireless, MetroPCS, and Clearwire, respectively.

 

For now, Crown Castle is the largest wireless infrastructure player in the market and has long-standing relationships with the major carriers. It’s hard to imagine any of them being able to operate a network without the use of Crown Castle’s products and services, which likely explains the excellent 2% non-renewal rate the company has historically enjoyed.

 

Besides customer concentration risk, Crown Castle could be impacted by changes in wireless deployment technology.

 

If wireless networks become more efficient (e.g. network sharing) or experience a substantial change in design, demand for Crown Castle’s wireless infrastructure could decline.

 

Other technologies such as WiFi, small cells, satellites, and mesh transmission systems could eventually serve as substitutes for the company’s wireless infrastructure as well.

 

None of these potential evolutions can happen overnight, but they could potentially jeopardize Crown Castle’s earnings 5-10 years from now – no one knows.

 

The company’s industry is also heavily regulated by the FCC, FAA, and local ordinances. They control the siting of towers and oversee tower and antenna structures, amongst other issues. It seems unlikely that a new regulation would crop up and harm Crown Castle’s business, but the company does face some regulatory risk.

 

Finally, near-term demand can be impacted by trends in capital spending by the major carriers. If they decide to pullback on plans to expand their coverage or capacity, Crown Castle could temporarily see reduced demand for its wireless infrastructure. This risk factor doesn’t impact the company’s long-term outlook, but it could potentially cause near-term volatility.

 

Overall, there are a few risks that could jeopardize the company’s very long-term future. However, the near- to mid-term outlook looks good. Technology changes are likely to happen at a moderate pace, and it’s hard to imagine any of Crown Castle’s major customers no longer needing its services anytime soon.

 

Dividend Analysis: Crown Castle

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Crown Castle’s long-term dividend and fundamental data charts can all be seen by clicking here.

 

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Crown Castle’s Dividend Safety Score of 62 suggests that the company’s current dividend payment is pretty safe.

 

The dividend payout ratio is one of the most important financial ratios for dividend investing because it shows how much of a company’s earnings are being consumed to pay the dividend.

 

Net income is most commonly used to compute a company’s payout ratio, but REITs face several complications.

 

REITs own a lot of property, so they record substantial non-cash depreciation charges every year, which reduces their reported net income. However, the value of real estate usually rises over time, creating a mismatch between accounting and reality.

 

For this reason and others, real estate businesses use a supplemental measure called “adjusted funds from operation” (AFFO) instead of net income to provide a better sense of their real dividend payout ratios.

 

AFFO measures cash flow by removing the non-cash impact of real estate depreciation along with several other items to give a more accurate look at a company’s operating performance.

 

For fiscal year 2016, Crown Castle expects AFFO per share of $4.70. With annual dividend payouts of $3.54 per share, the company’s forward-looking payout ratio stands at 75%.

 

I generally prefer to invest in companies with a lower payout ratio but will make exceptions for businesses with extremely steady cash flows.

 

Crown Castle seems to fit this profile. The company generates consistent cash flow thanks to its long-term leases, mission-critical services, large base of recurring revenue, and high renewal rate.

 

As long as the company continues to retain its tenants and continue collecting monthly rent payments, the relatively high payout ratio shouldn’t be an issue.

 

Another one of the most important factors impacting dividend safety is a company’s performance during the last recession. As seen below, Crown Castle’s revenue continued growing at a double-digit clip throughout the downturn.

 

 

Economic weakness did not significantly impact Crown Castle’s recurring revenue, and demand for wireless services continued to grow. Site rental revenues increased at a mid-single digit clip throughout the downturn, underscoring its resiliency.

 

Despite stable fundamentals, Crown Castle’s stock plunged by nearly 60% in 2008, significantly underperforming the S&P 500.

 

In 2008, the company had around $240 million in cash on hand compared to total book debt in excess of $6 billion. As credit markets froze up, many highly leveraged companies such as Crown Castle were smoked.

 

A similar situation seems unlikely in today’s age of rock-bottom interest rates and easy money, but the company’s history is worth being aware of.

 

Besides stable business results across many different economic environments, Crown Castle’s excellent free cash flow generation boosts its Dividend Safety Score.

 

As seen below, Crown Castle has generated positive, growing free cash flow over the last decade. Most of the company’s costs are fixed, which allows it to generate high incremental cash flows when it adds new tenants to existing towers.

 

Maintaining its wireless infrastructure is also relatively inexpensive. The company estimates that sustaining capital expenditures are typically just 2-3% of net revenues. If another downturn were to happen, Crown Castle could easily ramp up free cash flow by cutting out discretionary spending.

 

 

As I mentioned earlier, Crown Castle does maintain a high debt load. Debt can be good or bad depending on the type of business (e.g. cyclical versus stable) and the amount of leverage used.

 

Since Crown Castle generates extremely stable free cash flow and owns a good portion of its land and properties, it can reasonably afford to maintain more debt than the average firm.

 

The figure below shows that Crown Castle currently holds $305 million in cash compared to a debt load of nearly $12 billion.

 

The company is committed to improving its balance sheet and maintains an investment grade credit rating from the major agencies. It also has around $2 billion available to use from its credit revolver, alleviating some of my leverage concerns.

 

 

Overall, Crown Castle’s dividend payment looks safe. The company’s payout ratio is reasonable, its free cash flow generation is excellent, and the services provided by Crown Castle are at least somewhat recession-resistant. The balance sheet could be in better shape, but the company’s reliable cash generation reduces some of this risk.

 

Dividend Growth Score

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Crown Castle’s Dividend Growth Score of 50 suggests that the company’s dividend growth potential is average.

 

The company began paying a dividend in early 2014 and raised its quarterly payout from 35 cents per share to 82 cents at the end of 2014.

 

Most recently, management increased Crown Castle’s dividend by 8.5% at the end of 2015, raising it from 82 cents per share to 89 cents.

 

 

The company targets 6-7% long-term annual growth in dividends per share going forward, which is similar to the S&P 500’s historical dividend growth rate.

 

Since REITs are required to pay out at least 90% of their taxable income as a dividend and are often capital-intensive businesses, their dividend growth rates are usually low but consistent.

 

Crown Castle scores better for Dividend Growth than many other REITs because much of its future growth requires little capital (e.g. adding additional tenants to existing towers; annual price escalators).

 

The company’s reasonable AFFO payout ratio (75%) is also supportive of decent dividend growth, especially considering the low amount of sustaining capital expenditures required by the business (i.e. if Crown Castle cut back on growth investments, its AFFO payout ratio would drop and provide even more room for dividend increases).

 

While the company is too young to be considered a blue-chip dividend stock, it’s dividend growth profile over the next few years looks healthy.

 

Valuation

Crown Castle’s stock trades at 19.7 times forward AFFO per share guidance and offers a dividend yield of 3.8%.

 

If AFFO per share grows at management’s targeted rate of 6-7% per year, the stock appears to offer annual total return potential of 10-11%.

 

The stock’s current valuation seems reasonable considering the company’s stability, but I’d prefer to own the stock at a somewhat lower cash flow multiple for a greater margin of safety.

 

Conclusion

The investment case for Crown Castle over the next five years is very interesting.

 

As demand for data and wireless connectivity continues to grow, Crown Castle’s wireless infrastructure should become even more valuable.

 

The company has room to add more tenants to its existing towers at very high incremental margins and will continue to enjoy annual price increases across its portfolio of leases.

 

These two factors should help earnings and dividends continue to grow at a mid-single digit clip.

 

Crown Castle looks like an interesting business for dividend growth investors to keep an eye on, especially if the stock sees a pullback.