Is Verizon Undervalued?

| About: Verizon Communications (VZ)

Summary

EV/EBITDA multiple shows the stock is undervalued.

The valuation is backed by consistent growth in revenues, as well as profitability.

The company has substantially improved its margins, and currently, its operating margin is substantially higher than the industry average.

Verizon (NYSE:VZ) is the largest telecommunications company in the U.S., complemented by its huge customer base and comparatively better data services than its competitors. However, the start of the year has not been kind to telecom stocks, and Verizon's stock is down about 4% year-to-date. We believe the recent sell-off has created a good opportunity for income investors, as well as long-term investors to pick up some shares at a discount. In our previous article, we discussed the company dividends and the dividend growth prospects in detail. The focus of this article will mainly be the valuation of the stock.

We are taking enterprise value and EBITDA multiple into consideration for the valuation of the stock. Enterprise value is the value that a prospective buyer will have to pay for the whole company. This measure values the business of the company, instead of just valuing the company. I believe this measure provides a better picture than the market capitalization, as it also includes the debt of the company. If a buyer were to take over a company, he/she will have to assume the debt of the company as well, and the buyer will get the cash and other liquid assets of the company, which can be used after the takeover. In order to calculate the enterprise value, we add debt, preferred share capital and the minority interest to the market capitalization of the company, and deduct cash and cash equivalents - the resulting value is the enterprise value of a company.

According to the calculations, the current enterprise value of Verizon is around $291 billion, which on a per share basis, equals around $100. Currently, the stock is trading at approximately $47 per share, substantially below the enterprise value of the stock. However, the reason for this significant increase is due to the addition of debt, preferred capital and minority interest in the enterprise value. A better measure is the comparison of the EV/EBITDA multiple of different players in the sector - this can give us a hint whether a stock is undervalued or overvalued. The EBITDA (earnings before interest, taxes, depreciation and amortization) value for the company stood at around $48.5 billion for the last year. The EV/EBITDA multiple for the company stands at around 6x. EV/EBITDA ratio is a better measure in stock valuation as compared to P/E ratio, because it is not affected by the changes in the capital structure.

In the table below, we have compared the EV/EBITDA multiple of Verizon with some of its industry peers. The table includes the EV/EBITDA multiples of AT&T (NYSE:T), Sprint (NYSE:S) and Windstream (NASDAQ:WIN).

Verizon

AT&T

Sprint

Windstream

EV

$291

$260

$57

$14

EBITDA

$49

$50.10

$3.70

$2.30

EV/EBITDA

5.9x

5.2x

15.5x

6.1x

Click to enlarge

Source: Morningstar

According to the table, the EV/EBITDA multiple of Verizon is higher than its biggest competitor, AT&T. However, the other two industry peers have higher EV/EBITDA multiples than Verizon. A lower EV/EBITDA multiple usually indicates a stock is undervalued. Both Verizon and AT&T look attractively priced at current levels. In our previous articles, we have recommended AT&T due to the solid growth potential in dividends and attractive valuation. The EV/EBITDA multiple also shows that these two stocks are attractively priced.

Verizon's valuation is also supported by a consistent increase in profitability observed in the last few years. The operating margin for Verizon has gone up to 26.5% from just over 11.4% a year ago - Verizon's operating margin is almost double the industry average of 15%. The company also has huge potential to grow its profits in the coming years by taking certain measures - Verizon made an investment of $711 million in infrastructure improvements for both its residential as well as business segments. The company has invested around $3.7 billion in the state of Virginia, with the addition of 20,000 miles of fiber optic wiring. Telecom companies mostly derive their future growth from intense infrastructure capital spending, and this expenditure will allow the company to continue its impressive growth in profitability and cash flows. Also, telecom companies are now expanding their wireless spectrums by acquiring smaller struggling companies. Verizon recently acquired Cincinnati Bell's (NYSE:CBB) spectrum for $210 million, which is intended to enhance its spectrum position and provide the company with more wireless capacity.

Conclusion

The EV/EBITDA multiple shows that the stock is undervalued at the moment. The takeover of Verizon Wireless from Vodafone (NASDAQ:VOD) has resulted in a massive increase in the long-term debt of the company. As a result, the enterprise value has gone up, along with the EV/EBITDA multiple. However, the multiple is still better than some of its peers, and AT&T's EV/EBITDA multiple is helped by the lower debt of the company. We believe Verizon and AT&T are both extremely attractive investments in the telecom sector - both these companies have solid dividends, with impressive dividend growth and strong cash flows.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.