Jim Simons likes Cogent, but C
If you run a stock filter for companies paying a dividend of more than 6% that have a GF score above 80, you will get a relatively short list. Cogent Communications Holdings Inc. (CCOI, Financial) is one of the few stocks on this list, and it looks good on many fronts, at least until you see a 359% dividend payout ratio. This should make investors immediately suspicious of its sustainability.
Jim Simons (Trades, Portfolio) of Renaissance Technologies owns more than 2 million shares and added more in the second quarter. His firm is not alone among institutional investors, who as a class collectively own nearly 76% of the company’s outstanding shares.
The Washington, DC-based company provides low-cost high-speed Internet access, private network services, and data center colocation space.
According to its 10-K for 2021, it is a facilities-based provider, meaning it operates on its own infrastructure rather than rented or leased wiring. It also means that it does not depend on local telephone or cable companies for Internet access and private network services.
It mainly serves small and medium-sized businesses located in multi-tenant office buildings. Typical clients include law and financial services firms, as well as advertising and marketing companies, healthcare providers, educational institutions, and other professional services.
Cogent indicated in its 10-K that it faces competition from incumbent telephone and cable companies, as well as facilities-based network operators. It also argued that it has many competitive advantages, including:
- Low operating cost
- Better control and superior delivery
- Reliable and high quality service
- Large addressable market
- High traffic balanced network
- A proven and experienced management team.
Over the past five years, it has generally outperformed its peer index, but trailed the S&P 500:
Cogent is highly leveraged, particularly relative to its operating income, which gives it a low interest coverage ratio.
This is perhaps to be expected given that it is a player in the telecommunications industry. These companies need to make major infrastructure investments upfront, and then continue to collect rents on those investments for years and years to come (unless disruptive technologies take hold).
Looking specifically at its total assets and total long-term debt and capital lease obligations, we find:
- Total assets at the end of 2011: $597.7 million
- Total assets at the end of 2021: $984.6 million
- Long-term debt and obligations under capital leases 2011: $374.6 million
- Long-term debt and obligations under capital leases 2021: $1.232 billion
- No short-term debt at the end of 2011 and 2021.
Thus, the company increased its debts faster than its assets.
On a more positive note, the company has created value for shareholders. Its return on invested capital is almost double its weighted average cost of capital; The ROIC is 12.06% against a WACC of 6.66%.
The company earns a high GuruFocus profitability ranking based on strong operating margin, good Piotroski F-Score, high profitability and predictability ranking of 4.5 out of 5 stars.
Except for its return on investment, Cogent’s profitability isn’t the best in the industry, but it manages to keep up with or exceed industry averages.
Reflecting the consistency of profitability, it has been profitable in nine of the past 10 years.
Due to its historical stability and anticipated growth in revenue and earnings per share, Cogent achieves one of the best growth scores in the industry. Projected EPS growth is particularly attractive. Past growth has been more anemic on revenue, but EPS growth has always been strong.
If we rate this as a dividend stock, I’d like to see some serious free cash flow growth. The three-year growth rate shown in the chart below is weak, but that’s because of a bad year in 2020. On a 10-year basis, FCF growth looks much more powerful. This type of FCF growth should reassure on the sustainability of the dividend.
Dividends and share buybacks
Now for the elephant in the room: can the company continue to pay its dividend?
As noted at the top of this article, Cogent has a generous dividend yield. This is partly because the stock price has fallen:
It’s also because the company has increased the dividend by an average of 15.80% per year over the past five years.
It turns out that the size of the dividend is a tricky point. Cogent has a payout ratio of 359%, calculated by dividing the dividend per share by the earnings per share excluding non-recurring items. If the result approaches 100%, most investors become cautious; with a payout 3.59 times higher than EPS without NRI, income investors should be running, not walking, in the opposite direction.
Still, the company has three guru investors, including one with a large stake. He also enjoys the support of many professional investors who run institutional investment firms, as well as insiders.
What these investors can do is base their payout ratios on operating cash flow (Cogent is a capital-intensive business) rather than earnings per share.
For 2021, operating cash flow was $170.2 million while dividend cash flow was $150.3 million. This equates to a dividend payout ratio of 88.30%, which is high but sustainable.
There’s not much to see for stock buybacks. On a 12-month basis, there are 47 million shares outstanding, and over the past 15 years the number has fluctuated between 45 million and 48 million.
Despite all the red bars on the GuruFocus review chart, Cogent gets a high ranking because of its GF price-to-value ratio. As of the close of trading on September 28, the stock price was $53.91 and the GF value was $69.41.
Therefore, the security is considered slightly undervalued:
Compared to the rest of the telecommunications industry, it is overvalued on both the price-earnings ratio and the PEG ratio basis.
Thanks to good profitability, growth and GF value ratings, the stock receives a relatively high GF score:
Three of the investment gurus tracked by GuruFocus held positions in Cogent at the end of the second quarter:
Jim Simons(Businesses, Portfolio) of Renaissance Technologies added 6.82% during the quarter to its already large stake. As of the close of trading on June 30, according to his company’s latest 13F report, he held 2,312,056 shares, representing 4.82% of Cogent’s outstanding shares and 0.17% of his company’s 13F stock portfolio.
chuck royce(Trades, Portfolio) from Royce Investment Partners made no changes during the quarter and finished with 16,276 shares.
Joel Greenblatt(Trades, Portfolio) of Gotham Asset Management bought 5,008 shares to create a new holding company.
In total, institutional investors held 75.84% of shares outstanding in the latest round of 13Fs and mutual fund reports. This equates to 36.42 million shares. Insiders still held a substantial 12.34% of the shares.
When looking for above-average dividend yields, it’s always wise to check dividend payout ratios. Anything over 100% could mean trouble ahead.
However, a dividend yield isn’t the only reason to buy a stock, and the gurus above certainly seem to find the stock attractive anyway. Also, due to different operating styles, certain types of companies, such as telecommunications, might be better valued using different measures for their dividends.
For income investors who are comfortable with the idea of doing their own accounting, Cogent may be a company to consider. It is a solid and growing company with an attractive dividend. However, for those who don’t understand the industry or how it pays this incredibly high dividend, it might be best to stay away.