Verizon: What To Do Amid The Price Uptrend?

Apr.12.13 | About: Verizon Communications (VZ)

The share price of Verizon Communications (NYSE:VZ) has risen by 15% year to date and just reached its 52-week high at $50.64. Despite Verizon's solid fundamentals, I am of the view that buyers should wait for a pullback as the current price level seems frothy. My opinion is supported by the following 5 reasons:

1. Verizon shares seem fully priced based on the company's financial performance relative to that of AT&T (NYSE:T), the firm's closest peer. According to the comparable table shown below, Verizon's consensus estimated revenue, EBITDA, and EPS growth rates are generally better than those of AT&T. The firm also demonstrates a better profitability performance as most of its margins and capital return metrics are above AT&T's levels. In terms of debt and liquidity, Verizon carries a lower debt load, and because of that as well as the higher profitability, Verizon was able to sustain a higher interest coverage ratio. Verizon's current and quick ratios are also above the peer benchmarks, reflecting a healthy balance sheet condition.

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Verizon's current price multiple at 18.0x next 12-month EPS is 19% above AT&T's earnings multiple, implying the firm's better performance in growth and profitability has likely been factored in the stock price (see chart above).

2. The price appreciation primarily took place in the past 2 months. However, market's consensus EPS estimates for 2013 and 2014 have not experienced notable revisions over the period, and analysts' average 5-year EPS growth estimate has even been lowered from 9.2% to 8.7% since 2 months ago, implying an increasingly expensive valuation (see charts below).

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Verizon's forward P/E multiple is currently trading at a 21% premium over the same multiple of S&P 500 Index, which appears to be somewhat stretched based on its past 1-year trend relative to the index level (see chart below).

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3. Verizon's dividend yield is about to reach its 10-year low. From a technical standpoint and if history is a good guide, the dividend yield is likely to rebound from the current level driven by a dividend hike and/or a decrease in share price (see chart below).

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4. Sell-side analysts remain somewhat bullish on Verizon. Of the 34 total stock ratings compiled by Thomson One, there are 8 strong buy and 12 buy ratings. Nevertheless, the average 1-year price target of $49.2 is slightly below the current share price. As Verizon's cost of equity likely lies within 6% to 7% range based on the CAPM model (see chart below), sell-side's 1-year price target implies that the shares are overpriced by almost 7% if the theory holds.

5. The recent price run-up was partially fueled by investors' optimism about Verizon's acquisition of the remaining Verizon Wireless stake from Vodafone (NASDAQ:VOD). However, given the significant transaction size, the potential deal may not be transacted as smoothly as the market expects. In an April research note released by Guggenheim, the analyst, Shing Yin, had the following comment, which appears to be fair (sourced from Thomson One, Equity Research):

Given VOD's stake could be worth $115B or more, VZ would likely be unable to purchase the entire stake outright in cash. We believe VZW could raise $55-60B in debt to buy half of VOD's stake this year, and plan to buy the other half later using future cash flows. By our estimate, it would take Verizon Wireless at least seven years to save up enough cash to fund the second redemption, which we estimate could cost $80B+. This is because VZW's free cash flow has to continue to fund VZ's dividend and tax payments…While "saving" for the future redemption, VZ would have limited financial flexibility to engage in buybacks or other M&A.

As a lot of details are still unknown, there remain significant uncertainties. Given the share price is likely vulnerable upon disagreement, it is not worth the bet.

Bottom line, investors should be cautious for Verizon's modestly stretched valuation as the recent price uptrend was not supported by any notable fundamental improvements. Since I continue to view the stock as a solid long-term investment, shareholders should hold. For buyers, I would recommend pulling the trigger at a lower price.

All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the charts and the article is sourced from S&P Capital IQ unless otherwise specified.

Disclosure: I am long VZ. 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.