Updated: Oct 19, 2021
Are the investments Lumen (LUMN) is making creating value or destroying value? One way to get a feel for this is to compare ROIC (Return on Invested Capital) to WACC (Weighted Average Cost of Capital). We will look at data over a ten-year period to see specific yearly performance but also to get a feel for where the company is going. Up through 2016 and part of 2017 reflect Old CenturyLink and previous management. The next few years reflect the integration of the company cultures, etc.
Here is the deal with this comparison, If ROIC is greater than WACC+2%, the company is creating value because the company is investing in value-creating projects. If ROIC is lower than WACC+2%, the company is destroying value because the projects it is investing in are lower than the costs of funding that project. That is the theory, but nothing is set in stone given all the moving parts so the difference between ROIC and WACC+2% should not be a stand-alone analysis. Why WACC +2%? It is my way to be sure value is being created and not just running in place so to speak. If ROIC – (WACC+2%) is negative, value is being destroyed, if positive value is being created (Bar chart; red is negative; green positive). The stock price (Line) is added to see if there is any correlation. (Data source is GuruFocus)
First the visuals: (updated thru 2Q21)
According to this view value was being destroyed for years and the stock price followed this trend. Value creation appears in 2019 although the stock is not reflecting this though 2020. It has started up in 2021. Given the many years of value destruction maybe there is a lag in the stock price due to the horrible sentiment created over this time frame, but I speculate.
I am hopeful but would like to see gross margin dollars reverse its negative trend. Gross margins tell us the company is losing more dollars from lost business than it is creating through new business and 2021 guidance does not appear to change this trend. If the change depicted above (red to green) is permanent going forward, then it is only a matter of time before sales increase to the point of reversing the gross margin trend. If gross margins reversed in 2021, I believe they would have no choice but to raise guidance. That is the hope anyway.