Those that follow my writings know Level 3 Communications (LVLT) has been the focus stock on my website since mid-2013. One complaint I hear most is revenue is growing at single digit rates, i.e, not high enough. One metric that is not talked about is expanding gross margins. Here’s a snippet taken from the summary tab of the LVLT interactive pricing model:
Gross margins have been expanding for years (accounting for acquisitions noted above). If gross margins were not expanding (using 2014 margins) it would take 10+ percent revenue growth to generate the same projected 2015 operating income at the higher margins.
The interactive model has been extended through 2020. Revenue growth is projected to stay in single digits while margins are expected to grow to 68%, although at the rate they are expanding they should easily exceed this but we’ll stay conservative for the purpose of this analysis.
What will drive the stock price is the long term growth of EPS or FCF or a combination of both. The present model uses 2016 (since 2015 is heavy on TWTC integration) as the starting point and measures growth through 2020. The CAGR for both for the next 5 years comes in at about 18.5%.
The stock has been marked as a buy since late August on the fair value list with an entry target under $49. In the past I’ve said I met my quota of LVLT stock but have exceeded this quota as the stock moved into the low 40’s by buying long term calls and writing both short and long term puts. How all this will play out is yet to be known but all indications show a stock that is much undervalued; we’ll see.