- Given multiple opportunities, Verizon should see healthy wireless growth ahead.
- Conservative assumptions show that Verizon can continue driving 3%+ annual dividend growth and $10-$15B debt reduction through 2016.
- Trading below market and AT&T's valuations, Verizon offers great value at current level.
The share price of Verizon Communications (NYSE:VZ) has been weak year to date by losing almost 2%, compared to a 3% return for S&P 500 Index and 1.7% return for AT&T (NYSE:T). Since mid-March, the price has risen by 4%. I believe the recent uptrend is just the beginning as Verizon's growth prospects continue to look promising and the stock valuation appears to be cheap on relative basis.
As the Verizon Wireless deal has been closed, management's focus now shifts back to tackle the increasingly competitive wireless environment and shareholder value creation. Over a medium term, I believe Verizon is best positioned among its peers to continue driving healthy growth in the wireless world given the company's multiple growth opportunities. First of all, Verizon's strong wireless network continues to represent a competitive advantage given its better user experience. Management has indicated a plan to incur higher capital expenditure for continued network development. The company's 4G conversion remains in early phase. As of today, Verizon's customers still use a total of 50M 3G smartphones and feature phones. As the conversion to 4G continues, average revenue per user ("ARPU") should improve as 4G users are likely to spend more on data and other value-added features. In addition, the ARPU metric should see further improvement as new technology features such as "Voice over LTE ("VoLTE")" and Multicast come online in near term. To further enhance shareholder value, management has announced a deleveraging plan and will continue to make dividend payment.
Current consensus estimates expect total revenue to increase by 3% CAGR from $120.6B in 2013 to $131.8M in 2016 (including 100% Verizon Wireless) and EBITDA to decline slightly to $48.3B by 2016 owing to the Verizon Wireless deal. Given the reasons mentioned earlier, these estimates appear to be fair in my view. I have performed a cash flow analysis to gauge Verizon's capacity to support both healthy dividend growth and debt reduction over the coming 3 years. My calculation started with the consensus estimated EBITDA for 2014, 2015, and 2016. I noted that the company was able to convert at least 80% of annual EBITDA to operating cash flow in the past 5 years. To be conservative, I assumed a 67.5% conversion rate over the forecast period, which has accounted for the impact from Verizon Wireless integration. On the capex front, I assumed a 3.5% annual capex growth from 2014 to 2016 which is notably higher than any capex growth rates in the past 5 years. This is consistent with management's expectation that capex in near future may trend up slightly owing to continued spending on network development. My dividend forecast in 2014 is based on current dividend level and has factored in additional shares issued for the Verizon Wireless deal. I assumed dividend to grow by 3.5% per annum thereafter through 2016, which is consistent historical dividend CAGR of 2.8% since 2011. Based on these assumptions, my analysis yields a cumulative cash surplus of almost $14B in between 2014 and 2016, which can be deployed for debt reduction (see chart below). Assuming no material change in Verizon's current enterprise value at approximately $300B and cash position over the forecast period, a debt reduction of $14B should result in an almost 10% return for shareholder.
Verizon's valuation looks attractive at the current level. At ~$48, the stock trades at 12.5x consensus estimated 2015 EPS. The valuation is at 22% discount to the same multiple of S&P 500 Index at 16.1x. I believe the market discount is exaggerated as 1) Verizon's valuation gap to S&P 500 averaged at 0.4% in the past 12 months; 2) the company's consensus long-term EPS growth estimate of 9.1% is fairly in line with the average estimate of 9.5% for S&P 500 companies; and 3) the stock's 4.4% dividend yield is much superior to S&P 500'average at just 1.9% (see chart below).
Further, Verizon's 2015 forward P/E multiple also trades slightly below AT&T's despite the facts that AT&T's consensus long-term earnings growth estimate is only 5.5% and its 2014 estimated EBITDA margin of 33% is below Verizon's 36% (see chart below). It should be noted that it is the first time that Verizon's forward P/E trades below AT&T since 2010.
In conclusion, Verizon is a strong buy at the current level as the company is poised for good growth in the competitive market environment while the stock valuation is cheap on relative basis. The deleveraging process and continued dividend growth should provide a solid downside protection.
All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.