Shares of Verizon Communications (VZ) have declined 15.1% from their 52-week high of $48.77 attained in October. I believe the pullback presents investors a significant buying opportunity for this quality long-term investment given Verizon's intact fundamentals, tempting valuation, and lofty dividend yield at 5.0%. In this article, I will elaborate on the value analysis that supports my bullish view.
Verizon's valuations are attractive based on the firm's solid financial performance relative to its peers' (see comparable analysis table below). Analysts on average predict Verizon's revenue, EBITDA, and EPS to rise by 2-year CAGRs of 4.0%, 18.7%, and 83.8% over the current and next fiscal years. The growth estimates are generally better than the averages of 6.3%, 7.4%, and 19.8% for a peer group consisting of Verizon's primary competitors such as AT&T (T) and Sprint Nextel (S). In addition, Verizon's EBITDA margin is forecasted to expand by 8.0% over the same period, compared to the peer average of only 0.4%. On the profit side, Verizon's profitability level is somewhat comparable to that of the peer group. The company's profitability margins are slightly below the par, but its ROE and ROIC ratios are above the peer averages. Verizon carries a relatively lower level of debt as reflected by the firm's below-average debt to capitalization and debt to EBITDA ratios. In terms of liquidity, Verizon's trailing free cash flow margin is in line with the peer average. Due to the lower leverage, the company was able to maintain an above-average interest coverage rate. Both Verizon's current and quick ratios are on the par, reflecting a healthy balance sheet.
To summarize the financial comparisons, Verizon's financial performance is somewhat superior to the average level of the industry peers, and given the company's large firm size and significant market share, a premium stock valuation should be reasonably substantiated. Nevertheless, the current stock valuation at 5.3x forward EV/EBITDA, 14.0x forward P/E, and 1.66x PEG represent an average valuation discount of 3.4% to the peer-average trading multiples, suggesting that the stock is likely oversold.
Moreover, Verizon's forward P/E multiple is now trading at only 7.3% premium over the same multiple of the S&P 500 Index (see chart below). The trading multiple premium has decreased from 19.9% in a year ago. I believe Verizon's P/E ratio should command a higher premium over the market level provided that 1) Verizon's long-term estimated earnings growth rate of 8.4% is above the average estimate of 7.9% for the S&P 500 companies; and 2) Verizon's forward dividend yield at 5.0% is considerably above the dividend yield of 2.2% for the S&P 500 Index.
Verizon's lofty dividend yield and dividend growth would provide a solid protection to the stock's downside. The company has steadily raised its quarterly dividend per share three times since 2010. The growth rates were 2.7%, 2.5%, and 3.0%, consecutively. Given the current low-interest market environment, I believe Verizon's 5.0% dividend yield would have a limited upside as even a slight yield improvement will likely attract a substantial demand from the income-oriented investors. As such, assuming a target yield range between 4.5% and 5.5%, and supposing that Verizon' annualized dividend per share would be raised by just 2.5% from the current level of $2.06 to $2.11 in the October 2013 payment period, this base-case scenario would imply a stock price range between $38.39 and $46.92. The low end represents a downside of only 7.3% below the current market price.
National Securities recently initiated a buy rating for the stock with a target price at $50.00. Jefferies' equity analyst, Thomas Seitz, elaborated on his bullish thesis in his recent research note (Thomson One, Equity Research):
"1) Verizon has the most admired wireless network in the U.S. and is at least a year ahead of its competitors in deploying LTE.
2) Verizon's smartphone penetration is lowest of the national carriers, suggesting longer runway for growth.
3) Potential for significant dividend growth absent investment opportunities.
4) Higher smartphone penetration could drive continued ARPU growth - 4Q12 sub growth, in particular, may be exceptional.
5) Should macro-economy improve, the business wireline segment should exhibit significant operational leverage."
Based on a forward P/E multiple of 15.3x, which is 10% above the peer-average forward P/E of 13.9x, and assuming that the analysts' estimated FY2014 EPS of $3.19 can be maintained, one can arrive at a target stock price of $48.81. This estimated stock value is also supported by my DCF model which incorporates some conservative assumptions (see DCF table below, the author's assumptions are highlighted).
Bottom line, Verizon's margin of safety is firmly backed by the stock's cheap valuation, high dividend yield, and stable dividend growth prospect. As such, I recommend acquiring the shares now.
The comparable analysis and DCF charts are created by the author, all other chart s are sourced from Capital IQ, and all financial data in the article, the comparable analysis table, and the DCF model (except for the highlighted area) is sourced from Capital IQ.