Verizon (NYSE: VZ) stock has been on a roll lately, recently hitting a 52-week high and giving its shareholders an average return of 25% over the past three years. But with the competition getting tougher, can Verizon's share price maintain its momentum? Should investors prepare for an exit strategy, or hold on to their shares?
The Good News About Verizon
Since its incorporation in 1983 as traditional landline phone operator Bell Atlantic, Verizon has successfully reinvented itself as one of the leading mobile phone carriers in the US. It has made substantial investments in creating a wide-reaching wireless network and, in doing so, has succeeded in providing its customers with an outstanding service experience. It was the first company in the world to offer LTE (Long-Term Evolution) technology and recently upgraded its network to accommodate the latest version of 4G LTE. Verizon's coverage is presently at 476 markets, meaning that it reaches nearly 90% of the population.
Verizon's network also offers its customers a wide range of add-on services, such as complete TV and broadband services, which have tremendous potential in expanding its revenues. Its FiOS Video service already has some 4.7 million subscribers while its FiOS broadband offering has 5.4 million. Because of these services, Verizon is continuously able to increase its subscriber base. In the fourth quarter of 2012 alone, it activated a record 9.8 million devices. In addition, the company is in a good position to increase revenues further by offering premium services such as cloud storage and online payment systems, which could help boost further average income per user. It also recently added 'share everything' plans that would allow subscribers to avail themselves of a single pool of data that they can share among a combination of up to 10 smartphones and basic phones, and which includes unlimited talk and texting. With these plans, the company hopes to attract new subscribers who are looking to save money while being able to avail themselves of increased data usage.
Given the success of its business, it should not be surprising that Verizon's stock is riding high. The share price recently reached a 52-week high of $52.79 and is currently trading at $52.74, boosted by strong first quarter results. It reported profits per share of $0.68, a 15% increase from the $0.59 EPS reported in the same period last year, as well as a 4% increase in total operating revenues to $29.4 billion. These figures boosted its profits to $1.95 billion, up 15% from the $1.69 billion recorded in the previous year. As a result, the company's free cash flow has grown to $1.5 billion. Operating margin also grew to 21% from 18.4%, indicating that the company remains financially healthy.
Verizon is also trying to improve its bottom line by attempting to reduce the subsidies it is paying for its smartphones from Apple (NASDAQ:AAPL) and Samsung (OTC:SSNLF) through increased competition from new suppliers Microsoft (NASDAQ:MSFT) and BlackBerry (NASDAQ:BBRY). Microsoft is offering its Nokia Lumia 928 exclusively through the Verizon network, and though the new BlackBerry Z10 is carried by multiple networks, the white handset variant is being offered only through Verizon.
Unfortunately, Verizon faces a number of challenges that could impact on its profitability in the medium term. The most serious of these is increased competition from Sprint (NYSE:S), which recently closed a deal worth $20 billion from Softbank (OTCPK:SFTBY), which would give it a war chest of $8 billion that it could use to upgrade its network, reduce its debt and compete for the latest smartphones. This could potentially threaten Verizon's market share as well as put pressure on it to reduce prices to compete. Verizon currently controls some 37% of the market, while AT&T (NYSE:T) had 28% and Sprint, 12 percent.
Another issue that Verizon will have to face sooner rather than later is the saturation of the smartphone market. At present, some 50% of Americans already own a smartphone, which means that growth will eventually slow down as the market matures. Some analysts have predicted that the US smartphone market could reach 80% penetration by as early as August next year, after which it will be considered to be saturated. This is why Verizon has to focus on its add-on services to achieve continued growth. However, it faces severe competition in this sector as well, from cable companies and cloud app companies.
In the long term, Verizon faces threats to its profitability from having to service its obligations to pensions and healthcare benefits to its retired employees. The company currently has some 205,600 retirees to support, and some 183,400 employees. As more and more of their workforce retire, Verizon will see its pension obligations increase, which could hurt its profits.
The Bottom Line
While some analysts are saying that Verizon's stock price may have peaked and it has become overvalued, the company still has enough going for it that it is worth keeping in your investment portfolio. One factor that contributes to Verizon's competitive edge is that it has already spent money developing its 4G LTE network, while its competitors still have to catch up. The capital investments Verizon has made and is continuing to make in developing its network are setting the stage for its future growth. Thus, if you are a conservative investor who is willing to hold on to stocks longer term in anticipation of future profits, Verizon is vital in helping to build up your portfolio's worth.
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.