Verizon Communications Inc. (VZ) is a mobile carrier with a global reputation. In this article, we will discuss: 1) some company specifics indicating the financial strength or weakness of Verizon; 2) the future prospects with regards to changing industry norms. While reading this article, please note that the investment decision will be based upon the long-term prospects of the company.
Verizon claims in its recent annual report (2013) that it has a widespread presence in more than 150 countries. Verizon segregates its operating revenues into two major segments: Verizon Wireless and Verizon Wireline. As of the recent quarter's report, the wireless segment contributes 68% to the total operating revenues while about 32% of the revenues are attributable to the Wireline segment. Total operating revenues of the company have shown a growth of approximately 3.4% YoY as per the recent quarter's report. However, revenue contribution by each of these segments has remained relatively stable.
Comparing Verizon with its peers, we see that its debt to equity ratio significantly exceeds the industry average where the company's ratio stands at about 241 compared to the industry average of 37.12. Comparing the investment return, Verizon's ROE was calculated to be 31.94 in comparison to the peer average of 22.98. Considering that the company's ROE exceeds the industry's, I considered it important to analyze the drivers of the investment return using the DuPont analysis to see if the ROE's major contribution is derived from the company's core operations or its financial policy. The breakdown of the ratio is shown below.
In the graph above, we see that although the company's profit margin is fairly close to its competitors, its ROE is probably higher than the industry because of its weaker financial policy. Moreover, Verizon's asset turnover ratio falls short of meeting the market competitive level by 32%. A lower than industry profit margin and asset turnover ratio with a higher level of debt makes the ROE of the company unsustainable. Nonetheless, a strong balance sheet is evident by the fact that Verizon's CFO figure increased by 23.30% YoY as per the fourth quarter earnings release and its CFO/debt ratio has remained stable over this time at 0.22. To further improve this scenario, Verizon is making investments that are likely to strengthen its profits from continuing operations that will in turn help manage its debt exposure.
Mobile phone use is expected to grow at a CAGR of 61 percent from 2013 to 2018, reaching a level of 15.9 exabytes per month by 2018. The images below represent the per year growth of mobile traffic (left) and geographical distribution of the growing traffic (right) for the stated time period.
Source: Cisco VNI Mobile, 2014
The growing mobile traffic will significantly benefit the top line of the company since Verizon is vastly spread across the globe. Moreover, considering that Verizon is a market leader, holding about 31% of the market share as measured by some researchers, it would be able to benefit largely owing to the swelling traffic volume assuming that its market share remains relatively stable into the foreseeable future. The chart to the right (above) breaks down the expansion of mobile traffic across the geographical regions. The figures in the parenthesis refer to the final share of the particular region in mobile traffic in 2018. As we move from left to right in the graph, we see that although traffic is surging in every region the highest growth in mobile traffic is attributable to the Asia Pacific region, growing at a CAGR of 67%. China and India are showing enormous growth potential. One research study indicates that in China approximately 3 billion devices will be connected to the internet by the end of 2016 compared to just 1.5 billion devices (approximately) in 2011. India's telematics production is on the rise as well, marking a production volume of 3.9 million telematics. India's mobile traffic growth was recorded at 112% YoY as of the third quarter of 2013, while China's growth rate was measured at 72% during the same period.
People around the globe are increasingly seeing mobile phones as an efficient mode of communication and as a portable device to stay connected to the internet 24/7. The rollout of 4G networks across the Asia Pacific region are on the rise and opens up further opportunities for Verizon considering the fact that Verizon's 4G network is the only 100% 4G network. The graphs below show the growing or decelerating popularity of 2G, 3G, and 4G networks.
Source: Cisco VNI Mobile, 2014
In the graph to the left, 3G and 4G networks will continue to grow in the foreseeable future whereas 2G's popularity is losing ground. Furthermore, the graph to the right indicates the percentage holding of each of these networks in the mobile market. The estimated share of 4G network will be 51% in 2018 which means that Verizon can benefit greatly simply because of the changing industry prospects.
I believe that Verizon is a good candidate for long-term investment because the industry is turning in favor of Verizon's core operations. The company's balance sheet is strengthening and it is making good strategic investments to support its expansion into high growth geographical regions. Verizon presently covers virtually the entire mobile population of America (97%). Verizon's profitability figures of its wireless segment in the US region are going to rise even further considering the fact that it has bought the 45% equity share of Vodafone (VOD) in their joint venture Verizon Wireless for $130 billion; the deal is expected to close by the end of this month. The buyout will benefit Verizon further by giving it a better exposure to high growth markets like India and Africa.