Verizon Will Likely Shed $15 Billion In Market Capitalization In 2013

Jan. 8.13 | About: Verizon Communications (VZ)

Verizon Communications (NYSE:VZ) is a world renowned telecommunication company. Despite the glamor and hype behind smartphone devices, the stock is set up for a major correction that could shed $15 billion off its market capitalization by the end of 2013. It will decline because investors have overbought the stock, pushing it to unsustainable valuations.

Qualitative Analysis

(Note: Information pertaining to Verizon Communications came from the annual shareholder report and shareholder quarterly report.)

Verizon Communications is split into two separate business divisions, wireline and wireless. The wireline is composed of voice, Internet access, broadband video and data, Internet protocol network services, network access, long distance, and other services. The wireless service includes wireless voice and data services and equipment sales, which are provided to businesses, consumers, and governments.

Verizon Communications anticipates future revenue growth as it introduces new smartphones, Internet devices such as tablets, and its suite of 4G LTE devices (product refresh cycle). The wireline segment of the business will experience continued revenue declines as customers look for other alternatives to traditional landline products/services. Verizon Communications primary focus is investments into its 4G LTE network. Growth is likely to continue due to the product refresh cycle of handset devices (3G to 4G LTE). Verizon Communications also anticipates that the higher-tier data packages will add further revenue/net-income growth going forward.

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Consumers have continued the adoption of smartphones over traditional phones, implying further improvements in margins from add-on data packages.

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Over the course of a year, the number of 4G LTE devices purchased increased from 3.1 million units to 14.9 million units. This is a 380% increase in the number of 4G LTE products on the Verizon network. Verizon Wireless continues to invest aggressively into its wireless infrastructure, while some may argue less is more. In the world of telecommunications, more is more.

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During 2009-11, Verizon Communications invested $50 billion into its wireless network; this is why Verizon has the best 4G LTE network.

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Source: Network World.

Verizon Wireless has the highest 4G LTE speeds on a consistent basis according to the graph above. Therefore, a $50 billion investment over the course of three years can make a huge difference in product quality. A high quality product, backed by capital expenditure, equates to happy customers.

I anticipate Verizon Wireless to continue to out-compete the competition, based on the overwhelming investment in capital expenditures. The growth in product adoption, the product refresh cycle, growth in demand for smartphones, and the improving economic outlook keeps me upbeat on the company's long-term growth. Verizon Wireless may show upside net income surprises by decreasing capital expenditures in future years. The free cash flow may result in Verizon Communications buying a bigger share of the Verizon Wireless business from Vodafone (NASDAQ:VOD).

However, Verizon's biggest issue is the fact that it has not been able to improve profitability despite seeing drastic improvements in operating revenue over the past five years. Analysts are hoping that Verizon will cut costs in order to achieve profit targets; however, this may not necessarily happen, which is a downside risk investors should be aware of.

Verizon Communications competes with AT&T (NYSE:T), Sprint (NYSE:S), and T-Mobile (OTCQX:DTEGY). Verizon Communications shares a 40% interest in Verizon Wireless with Vodafone.

Technical Analysis

Verizon Communications has tested the upper resistance level and broke below the trendline.

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Source: Freestockcharts.com.

The stock is trading below the 20- and 50-day moving averages and is above the 200-day moving average. The stock is in the beginning stages of a correction.

Notable support is $40.00, $42.50, and $43.75 per share. Notable resistance is $45.25, $46.25, and $47.25 per share.

Street Assessment

Analysts on a consensus basis have moderate expectations for the company going forward.

Growth Est.

VZ

Industry

Sector

S&P 500

Current Qtr.

11.50%

N/A

-54.50%

9.30%

Next Qtr.

13.60%

N/A

-14.90%

14.60%

This Year

13.50%

-23.80%

9.40%

7.10%

Next Year

16.80%

25.90%

55.50%

12.90%

Past 5 Years (per annum)

-2.21%

N/A

N/A

N/A

Next 5 Years (per annum)

11.52%

10.80%

8.84%

9.14%

Price/Earnings (avg. for comparison categories)

18.16

9.69

21.31

11.17

PEG Ratio (avg. for comparison categories)

1.58

2.03

6.03

1.18

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Source: Yahoo Finance.

The company shows reasonable growth as analysts on a consensus basis have a five-year average growth rate forecast of 11.52% (based on the above table).

Earnings History

11-Dec

12-Mar

12-Jun

12-Sep

EPS Est

0.53

0.58

0.64

0.64

EPS Actual

0.52

0.59

0.64

0.64

Difference

-0.01

0.01

0

0

Surprise %

-1.90%

1.70%

0.00%

0.00%

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Source: Yahoo Finance.

The average surprise percentage is nearly identical to analyst forecast earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

P/E Multiple

2003

$ 1.26

17.06

2004

$ 2.51

10.30

2005

$ 2.56

7.86

2006

$ 2.54

10.66

2007

$ 2.39

13.85

2008

$ 2.54

10.68

2009

$ 2.26

12.45

2010

$ 2.20

14.7

2011

$ 2.15

17.78

2012

$ 2.44

17.73

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Source: Data taken from the annual shareholder report, price history taken from Yahoo Finance.

(Note: The EPS figure was a non-GAAP adjusted diluted earnings per share figure because the company's non-controlling interest in Verizon Wireless was not being factored back into the EPS figure for the income statement.)

The EPS figure shows that throughout the 2004-12 period, the company has not shown any improvement to its net income. The company has focused on improving revenues and ignoring profitability for the past nine years.

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Source: Data from annual shareholder report.

By observing the chart we can conclude that the business is technology-driven and has a lot of upfront costs that keep it from becoming more profitable. However, I have built a forecast that assumes the company will manage costs better, which will eventually lead to more profitability.

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Source: Forecast and table by Alex Cho.

By 2018 I anticipate the company to generate $4.91 in earnings per share. This is because of earnings growth, cost management, and improving economic outlook. The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next five years.

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Source: Forecast and chart by Alex Cho.

Below is a price chart incorporating the past 10 years and the next six years, detailing 16 years in pricing based on my forecast and price history on Dec. 31 of each year.

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Source: Forecast and chart created by Alex Cho, data from the annual shareholder report, and price history from Yahoo Finance.

Investment Strategy

VZ currently trades at $43.42. I have a price forecast of $37.93 for Dec. 31, 2013. The stock is trading above value, meaning that investors should not consider a short-term investment position in the company.

Short Term

Over the next 12 months, the stock is likely to depreciate from $43.42 to $37.93 per share. This implies 12.6% downside from current levels. The technical analysis indicates a stock correction further backing my sell thesis on the stock.

Long Term

The company is a decent investment for the long term. Over the short term, investors are likely to lose a lot of money. Those losses will not be offset by the dividends and share appreciation until the end of 2015. Meaning that unless if you have the patience to wait two to three years to make a return on investment, you should consider other opportunities.

I anticipate VZ to deliver on the price-and-earnings forecast despite the risk factors (competition and economic environment). Verizon's primary upside catalyst is cost management, growing demand, and improving economic outlook. I anticipate the company to deliver on my forecast price target of $65.40 by 2018. This implies a return of 50.4% by 2018. When factoring back in the dividends (based on the table below) the company will generate a combined return of 81%. This rate of return is reasonable considering the low level of risk (five-year beta of 0.5).

Year

Dividend Yield @ $43.47 per share

Cumulative Total

2013

4.61

4.61

2014

4.80

9.41

2015

4.99

14.40

2016

5.19

19.59

2017

5.40

24.99

2018

5.62

30.61

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Source: Forecast and table by Alex Cho, dividend data from annual shareholder report.

VZ has a market capitalization of $124 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity. The long-term returns should be passed up, as other investments boast better yields over the same time frame.

Conclusion

Over the short term, investors should remain pessimistic on Verizon because the market has already priced 2014 into the price of the stock, and the valuation should correct in 2013. The conclusion is simple: Pre-existing shareholders should sell their positions in Verizon, while investors on the sidelines should wait for a much cheaper price to buy the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.