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3 Value Stocks That Are Paying Down Debt

Billy Duberstein, The Motley Fool

In general, it's good to steer clear of heavily indebted companies. Companies saddled with debt often get into trouble, not only because of the interest costs and principal payments, but also because they have less flexibility to make productive investments in tough times.

However, heavily indebted companies often trade at very low equity valuations, and can lead to outsize returns, should things go right. In fact, this is how the private equity industry has traditionally achieved its high returns. PE firms buy businesses with lots of debt, fix operations, pay down the debt, then sell at higher prices. Their ability to use leverage greatly enhances the final return of the initial equity investment.  

Sometimes, these "private equity"-style investments exist in the public markets. Three such plays that come to mind are AMC Entertainment (NYSE: AMC), CenturyLink (NYSE: CTL), and Cleveland-Cliffs (NYSE: CLF). While all three companies have the element of debt danger in common, all have low valuations, are in the midst of business transformations, and have recently announced or begun paying down their debt loads. Could these be the turnaround stories of 2019?

A young man in a suit and glasses throws dollar bills at the camera.

Image source: Getty Images.

AMC Entertainment

AMC Entertainment is the world's largest movie theater operator. It got to be that big through a debt-fueled acquisition binge in late 2016 and 2017, taking over Carmike (U.S.), Odeon (Western Europe), and Nordic (Northern Europe). Not only that, but after the acquisitions, AMC embarked on an ambitious renovation program that included the installation of luxury recliners.

Many of these acquisitions and renovations were funded with debt, and AMC's net debt has ballooned to roughly $5 billion, or 5.5 times its EBITDA. That has caused AMC's stock to remain under pressure since that time:

AMC Chart

AMC data by YCharts

However, there are reasons that debt may come down soon. After several years of heavy investments in recliner seating, AMC now says that it has completed the program for about 75% of its U.S. footprint. As such, AMC's capital expenditures will decline from $643 million in 2017 and $589 million in 2018 to approximately $300 million over the next few years. Even better, management says its maintenance capital expenditures are only $150 million, meaning capex could come down to that level at some point thereafter.

Management indicated those hundreds of millions in savings will now be put toward paying down debt, to a target of 3.5 to 4.5 times EBITDA within three years, with a longer-term target of just three times EBITDA. AMC also just refinanced $2 billion in debt, extending maturities all the way until 2026, giving the company even more time to hit its goals.

Nevertheless, AMC stock still remains under pressure -- perhaps due to the large debt load and a slow start to the box office this year; however, Avengers: Endgame just became the biggest opening weekend in film history, and a slew of other big titles are set to hit theaters this year. Last year's box office was a record, and 2019 has a shot at surpassing it. Should that happen, AMC's stock could begin making its way up toward previous levels.

CenturyLink

Like AMC, CenturyLink has also grown via acquisition. Most notably and recently, CenturyLink purchased Level 3 Communications in 2017, which was basically a huge merger of equals. That acquisition has made CenturyLink one of the largest telecommunications service providers in the world, with 450,000 route miles of fiber-optic cable across 60 countries.

It also came with a lot of debt, which as of last quarter totaled some $36 billion, good for a total debt-to-adjusted EBITDA ratio over 4.

In addition, CenturyLink is going through a transition period away from legacy copper phone lines and toward more fiber-based products for its enterprises. CenturyLink also gets about a quarter of its revenue from consumer broadband and cable -- a segment that has been under some pressure due to cord-cutting. All these factors are causing CenturyLink's overall revenue to decline.

Last quarter, management announced it was cutting the company's dividend, from $2.16 to $1.00. The executive team stressed that the company could have still covered the old dividend, but they thought it was best to invest in the business and pay down debt, instead of maintaining a high payout ratio. CEO Jeff Storey detailed a new target level of 2.75 times to 3.75 times adjusted EBITDA to be achieved over the next three years.

After the dividend announcement, CenturyLink shares fell. The company's dividend yield still stands at a whopping 8.7%, even after the cut. In addition, Storey has been able to expand profits and margins even while revenue has been under pressure. Should the company's financials stabilize and debt comes down in the next few years, a CenturyLink rebound could be in the cards.

Cleveland-Cliffs

While AMC and CenturyLink are at the beginning of their debt pay-downs, Cleveland-Cliffs has already made significant progress. Cleveland-Cliffs is an iron ore producer based in the U.S., but around the time of the 2008 financial crisis, its prior management team made a slew of ill-fated acquisitions into overseas mining operations and non-iron-ore endeavors, such as coal.

However, new CEO Lourenco Goncalves took the reins in 2014 and embarked on a new strategy. This included selling non-core businesses, improving operations, and renegotiating contracts with customers to provide more stable cash flows.

These initiatives have allowed Cleveland-Cliffs to pay down debt, from over $2.8 billion at the end of 2014 to just $2.1 billion at the end of 2018, against $821 million in cash.

In fact, the streamlined approach has worked so well that Cleveland-Cliffs felt comfortable initiating a quarterly $0.05 dividend last fall, along with a $200 million share repurchase program, which the company just upped to $300 million on its last conference call. This is a stark change from just a few years ago, when many analysts thought the company might go bankrupt.

Going forward, the fallout from Vale's (NYSE: VALE) Brumadinho dam disaster should keep iron ore prices elevated for the foreseeable future. Yet investors don't seem willing to forget Cleveland-Cliffs' tumultuous past, with the stock trading at just seven times forward earnings.

Nevertheless, with the company continuing to pay down debt and now returning cash to shareholders, I wouldn't expect the valuation to stay at this low level, given its improved financial condition.

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Billy Duberstein owns shares of AMC Entertainment Holdings, CenturyLink, and Cleveland-Cliffs and has the following options: short May 2019 $11 puts on CenturyLink. His clients may own shares of the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.