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In my previous article, I performed a quantitative analysis of telecom major AT&T (NYSE:T). In this article, I will perform a similar exercise on its closest competitor Verizon (NYSE:VZ). Of the two companies, Verizon has performed significantly better during the past 52 weeks. The stock is up 18% compared to the 3% appreciation in T's stock price. However, VZ has underperformed the market with the S&P 500 rising by 22% during the past year. The stock currently yields a respectable 4.2%. For reference, T's current yield is slightly above 5%. During the past 52 weeks, VZ has traded between $40.5 and $54.3. At the time of writing, the stock was trading just below $50 a share.

In this article, we will examine the company's fundamentals and perform a valuation analysis to determine if the stock is cheap at current levels.

Growth:

VZ's revenue growth rate has been fairly consistent over the past 3 years averaging 3% on an annualized basis. During the last quarter, the revenues were up 4% compared to the same quarter of the previous year. Net income and EPS both jumped by about 15% during the most recent quarter. The EPS increased at an annual rate of 3% during the past 3 years. Going forward, the company is expected to increase its earnings at an annual rate of 10.5% compared to the 7% rate of the industry. The growth rates are presented in the table below.

Growth Rates

3 Year

YOY

QOQ

Revenue

3%

4%

4%

Income

-23%

-64%

16%

EPS

3%

-30%

15%

Growth Estimates

VZ

Industry

S&P500

Next Year

15.00%

4.30%

12.10%

Next 5 Years

10.48%

6.78%

9.40%

Profitability and Operations:

VZ reported average gross margins of 60% during the past 3 years. The operating margins have remained steady in the 12% range. The return on equity and return on assets generated by the company are terrible in my opinion. The profitability and operational metrics are shown below. For comparison, T reported return on equity of 8% and return on asset of 3% during the trailing 12-month period.

Profitability & Operations

3 Year

1 Year

TTM

Gross Margin

60%

60%

47%

Operating Margin

12%

11%

12%

Net Margin

2%

1%

1%

Return on Equity

5%

3%

3%

Return on Assets

1%

0%

1%

To compare VZ to its competitors, key operational and valuation metrics for its peers were obtained. The peer group selected for analysis included Sprint (NYSE:S) and AT&T. The table below presents the peer analysis results.

Ticker

Mkt Cap

Price

P/E

P/S

Lt D/E

ROI

GM

OM

T

191.21B

35.26

27.53

1.51

71.85

3.14

56.67

10.15

S

21.73B

7.2

-

0.62

338.11

-10.11

41.04

-5.15

VZ

138.19B

48.3

121.52

1.21

143.61

7.14

60.05

11.36

As shown above, VZ trades at a slight discount to T on a sales multiple basis. The long-term debt-to-equity is also double that of T. It however generates better margins than T and S. The return on investment is also higher than the 2 peers selected.

Valuation:

Valuation analysis was performed using relative valuation. A cost of equity of 12.2% was calculated and used in this analysis. Based on historical analysis, I arrived at a fair P/E ratio of 22 for VZ, which was used in this analysis. This multiple would imply a slight premium to my expected P/E multiple of 21 for T owing to the faster growth rate and slightly better margins. The analysis is shown below:

Valuation

VZ

Next Yr Proj EPS

$3.22

EPS Growth Rate

10.48%

Future EPS (5 Yr)

$4.34

Expected P/E

22

Price 5 Yrs Out

$95.53

Unlevered Beta

1.06

D/E Ratio

38%

Current Tax Rate

35%

Levered Beta

1.32

Risk Free Rate

2%

Risk Premium

8.00%

Size Premium

-0.36%

Cost of Equity

12.2%

Fair Value

$55.29

Current Price

$48.30

% Overvalued

-14%

In addition to the analysis above, sensitivity analysis was also performed to evaluate the impact of the growth rate and cost of equity on the final valuation. The result of this analysis is shown below:

Growth Rate
$55.298.5%9.5%10.5%11.5%12.5%
Cost of Equity10.2%57.058.660.261.963.6
11.2%54.656.157.759.360.9
12.2%52.353.855.356.858.3
13.2%50.251.653.054.555.9
14.2%48.149.550.852.253.7

As shown in the above, based on my analysis, the fair value of VZ is $55 a share implying a return of 14%. Adding dividends, a return of 18% is possible. Trading at $49, the growth rate will have to fall to 8.5% compared to the analyst forecast of 10.5% and the cost of equity rise to 14% for the stock to be overpriced at current levels. In my opinion, the stock is a bargain and I would look to initiate a position on further weakness. Between T and VZ, I would prefer being invested in T based on the lower debt-to-equity ratio and slightly higher return on equity and return on asset ratios.

(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision)

Source: Verizon - Low Risk Return Of 18%