I reiterate my bullish stance on Verizon Communications Inc. (NYSE:VZ), as it has managed to deliver strong wireless growth in the recent third quarter. The company has also managed to improve its wireline revenues. With a solid dividend yield and long term wireless growth opportunities, VZ continues to paint an encouraging outlook.
Regulatory authorities have made their intentions clear by striking down a deal between T-Mobile (NYSE:TMUS) and AT&T, Inc (NYSE:T). These intentions being that the authorities prefer the current structure of the industry, where there are four major players, and they will not approve any acquisitions and mergers that change the dynamics of the industry. However, VZ still managed to almost double its wireless business in the U.S. when it decided to buy back its 45% share of Verizon Wireless. This deal will help the company keep all of its VZ Wireless earnings, which contribute a major chunk to its operating revenues and constitute nearly all of its free cash flows. So, I believe this was a very attractive deal and the results will be evident in VZ Wireless' future growth.
With the smartphone market nearing its maturity, the company's future growth will be primarily dependent on its M2M services. The company has been aggressively pursuing to develop and commercialize these M2M products and services in its innovation centers in Boston and San Francisco. Household services and businesses are already using these services in the simplest of forms, through the adjusting of thermostats, turning lights on and off etc. But with the passage of time, this will cater to more complex services that could be controlled with smartphones. Therefore, I believe this is the next big thing that will change the use of smartphones and will further enhance the use of high speed data networks. Currently, the company is focusing on healthcare, vendors, logistics, the retail sector and sensor networks.
I also believe that the company enjoys a better competitive position, as AT&T and Sprint (NYSE:S) have not yet finished their 4G LTE frameworks. Furthermore, AT&T is also focusing on expanding its operations in Europe, which will consume a major chunk of its resources. On the other hand, Sprint enjoys the largest spectrum, but is far behind in 4G LTE deployment. Hence, I believe it can enjoy a head start, similar to when it laid down the LTE framework.
Financial performance of 3Q'13
Total consolidated revenues were up by 4.4% YoY and reached $30.3 billion, above analyst estimates of $30.2 billion. In the wireless segment, service revenues, which contribute around 86% of wireless revenues, experienced a rise of 8.4% YoY. Retail postpaid service revenue per account reached $155.74, with an increase of 7.1% YoY. Postpaid net additions were lower-than-expected, as the company only managed to add 927,000 accounts, meaning a decline of 39.6% YoY. It is expected that the postpaid base will improve next quarter, as the company experienced supply constraints for the iPhone 5s in the third quarter; demand will now shift to 4Q. VZ has experienced a rise in churn due to rising competition from Sprint and TMUS. It has managed to add 7.6 million smartphones as compared to 6.8 million in the same quarter of the previous year. Also, 29% of activations were new to the company.
In the wireline segment, consumer revenues experienced a rise of 4.3% YoY, as FiOS managed to add 173,000 and 135,000 internet and video subscribers, respectively. I believe the wireline segment will show significant improvement in 2014, as the company can now integrate its wireless and wireline services and can offer bundled products and services, which will help increase its customer base.
VZ is expecting its capital expenditure to be around $16.6 billion for the current year. The company can save precious cash, as it's nearing the completion of its 4G LTE framework and FiOS deployment. So, the company can focus on other projects, whereas other carriers will be busy completing their 4G LTE frameworks.
Wireless EBITDA margin has now reached 51.1% due to strong average revenue per account (ARPA) and lower equipment subsidies. Also, a large number of tablets were activated in the third quarter, which means lower subsidies along with a lower ARPA. Furthermore, VZ has also extended its upgrade cycle from 20-24 months, which will help reduce subsidy pressures. On the other hand, wireline margins have shown signs of improvement due to an improvement in revenue trends and a reduction in operational costs.
To raise $130 billion to buy back 45% of Verizon Wireless shares, VZ had to take on a large amount of debt i.e. $61billion. This debt has not only deteriorated its balance sheet, but it also forced S&P and Moody's to downgrade the company's rating to BBB+ and Baa1, respectively. However, the management is very keen to pay off the debt as soon as possible and bring back the leverage ratios to their normal levels. On the conference call, CFO and EVP of VZ, Fran Shammo, said,"…our projection is as we approach that less than two times we would get back to our historical rating of the A-. And we believe that with the free cash flow that we will generate off of this transaction we could pay that debt down and get there within a reasonable amount of time, somewhere between four and five years."
So, I believe investors should not worry about the enormous amount of debt, as it could be managed by the ample free cash flows.
Average P/E of VZ
VZ - Estimated 2014 EPS
Source: yahoo finance
The estimates for 2014 EPS are based on 100% ownership of Verizon Wireless. If we average out the bearish and bullish cases, the price target comes out to be $56.4 per share. The stock is currently trading at $50.51, which means there is significant upside potential for VZ. Furthermore, the company offers an exciting dividend yield of 4.20% which is higher than the 30-year U.S. treasury yield, which gives a healthy total return.
The Telecommunication Industry is dependent on an economic recovery and any additional spending is heavily dependent on the economic wellbeing of subscribers. Furthermore, the industry has experienced major consolidation, and smaller players like TMUS and S are aggressively competing and transforming into major players. A slowdown in wireless growth can hurt the company's future growth prospects.
Next 5 yr growth rate per annum
Source: yahoo finance
VZ has consolidated its position as the largest telecommunication company in the U.S. with striking results for the third quarter. Furthermore, the company also offers the highest growth rate for the future among its competitors. Also, VZ offers the cheapest growth rate, as indicated by the lowest PEG ratio. The company is also focusing to expand its M2M services, which would be able to generate new streams of revenues.