Verizon: Attractive Valuation With Promising Future

Jul. 1.13 | About: Verizon Communications (VZ)

In this article, free cash flow models and price to earnings multiple will be used to determine the intrinsic value of the company as carried out in my previous article. However, some different assumptions and updated free cash flows have been used to come up to the target price. Important features of Verizon (NYSE:VZ) in the first quarter of this year will be discussed as well.

Key highlights of financial performance of 1Q'13

· Verizon Communications Inc. has delivered an earnings surprise of 3.0% by beating the analysts' expectation of $0.66 per share.

· EPS has experienced a rise of 15.3% YoY and has reached $0.68 per share.

· Operating cash flow has increased by 27%, which means a rise of $1574 million YoY.

· Wireless segment has continued to be a growth driver with the rise of 23% in the operating income whereas, wireline segment did not perform well and the operating income decreased by 91.7%.

· 7.2 million Smart Phones were activated and around 28% of them were the new additions.

· 4G LTE network is now available in 491 markets in the US and around 5.9 million new devices have been activated.

· FiOS revenue grew by 15.1% YoY which is around 69% of the consumer's revenue.

Valuation

Free cash flow discount model

Assumptions

· Terminal growth rate is assumed to be 1.25%

· Public market discount is assumed to be 20%

· Equity & debt weights are assumed to be 70% and 30% respectively.

Calculation of discount rate

Weights

Cost of equity/after tax cost of debt

Discount rate

Equity

0.70

9.25%

6.475

Debt

0.30

3.645%

1.0935

7.5685

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All figures are in $ billions

Years

2014

2015

2016

Terminal Value

Free cash flows

13.526

14.712

15.469

247.88

Discount factor

0.9296

0.8642

0.8034

0.8034

Present value

12.573

12.714

12.427

199.148

Total value of firm (debt +equity)

236.86

Total debt

52.881

Total value of equity

183.98

Value of equity after public market discount

147.18

Total no. of shares

2.861

Share Price

51.44

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P/E Multiple

Forecasted Earnings

Historical P/E multiple

Share Price

Bullish case

3.65

16.1

58.76

Bearish case

3.03

16.1

48.78

Average Price=53.77

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VZ is currently trading at $50.69 which means that the stock is undervalued as the share price calculated by both methods is high. The company also offers an attractive dividend yield of 4% and it has sufficient cash flow strength to maintain its dividends.

Possible acquisition of Wind Mobile

The interesting recent development is the potential entrance of VZ in the Canadian market which will change a lot in both US and Canadian markets. As mentioned in my previous article, the competition is heating up in Canada. Several new companies are entering into the telecommunication sector in Canada after 2008 spectrum auction but it did not end up in enhancing competition as 90% of the telecommunication sector is still owned by three large companies. VZ seems to be interested in Wind Mobile. Consequently, the deal will not paint an encouraging outlook for the current market leaders of Canada as VZ is the largest telecom in the US with cutting edge technology. Moreover, VZ will have altogether a new market to explore and increase its subscriber base. However, it is too early to say that VZ will be able to acquire Wind Mobile or not.

Risk

Major threat to VZ is from the Sprint Nextel (NYSE:S) and SoftBank deal which will enable Sprint to update to 2.5 GHz spectrum across its network. Primarily, VZ is dependent on the economic conditions and additional spending on telecommunication networks is highly dependent on the economic recovery.

Conclusion

Companies

Net debt/ Adjusted EBITDA

P/S

Next 5 yr growth rate per annum

AT&T, Inc. (NYSE:T)

1.68x

1.49x

6.28%

BCE, Inc. (NYSE:BCE)

2.15x

1.64x

4.50%

VZ

1.2x

1.22x

10.48%

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It can be inferred from the table above that the company is very attractive in terms of key ratios. P/S and Net debt to adjusted EBITDA are very useful in evaluating mature companies. Moreover, growth rate for the next 5 years is way higher than that of its competitors. I expect Verizon to continue to be the leader in the telecom market with the solid dividend payout policy and immense growth opportunities.

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.