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Jeff Halpern, an analyst at Bernstein Research, this morning cut his rating on Verizon (NYSE:VZ) to Market Perform from Outperform. Halpern notes that investor opinion on the stock has turned around over the last 12 months; a year ago, he says, sentiment “could not have been lower.” Now, he says, Verizon has lead telecom to be the single best performing segment of the S&P 500 over the last 12 months.

But he sees more difficult times ahead. “With difficult earnings compares in 2007 due to the loss of earnings from several businesses and the recent run-up in its shares leaving it at a relative multiple from which we see little near-term upside, we are downgrading Verizon… and lowering our target price from $42 (including Idearc) to $38 (excluding Idearc).”

Halpern notes that the lower target price pulls out $1-$1.25 for the Idearc spinoff, “but also our belief that given the improved investor sentiment around the telecom group it is now more appropriate to value Verizon on earnings than on a pure discounted cash flow analysis.”

Halpern says “the spin-off of Verizon’s directory business later this month should be a market-neutral event,” but that Verizon excluding Idearc “is guaranteed to face difficult earnings comparisons for the next four quarters.”

Halpern says he sees three issues for Verizon over the next six to nine months:

  • An almost certain decline in subscriber growth at Verizon Wireless in 2007 versus a very strong 2006 due to the continued maturation of the market and stabilization in Sprint’s churn rate.
  • Disappointing near-term wireline margins due to a slower realization of wireline-specific synergies from the MCI merger.
  • Continuing dilution from FiOS [the company’s fiber optical cable project] at levels approximating those of 2006 ($0.31-0.32) including a modest increase in the rate of dilution in 4Q06 and maintenance of this elevated level through at least 1Q07.

Halpern cut his 2007 estimate to $2.52 a share from $2.66 to reflect the Idearc spinoff.

Adds Halpern: “For investors already holding Verizon’s shares and willing to weather a likely brief period of downward revisions, we are not recommending outright sale as we see significant organic EPS and free cash flow growth coming in 2008 and beyond.”

Verizon shares this morning are down 35 cents at $36.52.

Source: Trouble Ahead For Verizon?