Verizon Shows Off Cash-Flow Generating Prowess

| About: Verizon Communications (VZ)

Verizon (NYSE:VZ) reported in-line but strong second quarter results and raised its capital spending guidance for 2013, casting a positive light on the telecom equipment makers. We continue to pay very close attention to Verizon's operating performance, as we consider the firm one of our top contenders for addition to our Dividend Growth portfolio.

Verizon's revenue performance during the quarter was solid (up more than 4% on a consolidated basis), with wireless service revenues and wireless retail service revenues both up about 8%. The company posted 941,000 retail postpaid net additions (up 6% year-over-year), driving total retail postpaid connections to 94.3 million (retail postpaid churn was 0.93% in the second quarter). Apple's (NASDAQ:AAPL) iPhone accounted for 51% of Verizon Wireless' second-quarter smartphone sales (resulting in a better-than-expected 3.9 million iPhones). Wireline consumer revenues jumped nearly 5%, as consumer ARPU (average revenue per user) led the charge, advancing more than 9% from the same period a year ago. The firm experienced roughly a 15% increase in FiOS (fiber-optic service) revenues and noted it added its 5 millionth FiOS Video customer.

Verizon's strong top-line performance leveraged into a double-digit percentage increase in consolidated operating income (up 16%) and adjusted earnings per share, the latter advancing over 14% to $0.73. The company's consolidated operating margin came in at 22%, up 220 basis points on a year over year basis (a very nice showing). Free cash flow performance was outstanding, advancing to $9.5 billion (16% of revenue) in the first half of 2013 from $7.8 billion in the same period a year ago.

Verizon also announced that it is raising its capital spending guidance to the range of $16.4-$16.6 billion from $16.2 billion for full-year 2013, a modest nick to expected free cash flow, but a positive development for the telecom equipment space. Verizon's capital expenditures (including capitalized software) have been relatively consistent in recent years, totaling $16.175 billion and $16.244 billion in 2012 and 2011, respectively (but 2013 will be a definitive up year). The firm expects increased demand for wireless data consumption and plans to begin deployment of AWS (advanced wireless services) in the second half of 2013, both of which will drive the higher spending.

The spending hike, however, is in contrast to the direction of AT&T's (NYSE:T) capital spending forecasts, which were lowered in April by $2 billion to $20 billion for each of the next two years-2014 and 2015. Still, Verizon's increase is welcome news for Ciena (NASDAQ:CIEN), JDS Uniphase (JDSU), Juniper (NYSE:JNPR), Sonus Networks (NASDAQ:SONS), Allot Communications (NASDAQ:ALLT), Cavium (NASDAQ:CAVM), and Calix (NYSE:CALX) and a variety of other telecom equipment firms.

Valuentum's Take

We're huge fans of Verizon's cash-flow generating prowess, which is the primary factor behind its strong Dividend Cushion score. However, we continue to monitor the firm's wireless margins, given its recent phone-upgrade strategy in the face of consolidating and strengthening competition (SoftBank/Sprint/Clearwire; T-Mobile/MetroPCS; AT&T/Leap). Still, a 220 basis-point increase in its consolidated operating margin during its second quarter is nothing to sneeze at-and is largely unappreciated by the market, in our view. Still, we continue to exercise patience as we wait for an attractive entry point in Verizon for our Dividend Growth portfolio.

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.

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