Verizon: This Communications Giant Trades At A Modest Discount

Apr.16.12 | About: Verizon Communications (VZ)

Verizon (VZ) is a provider of communications, information and entertainment products and services. The stock was down 1% during the last year and flat over the last 5 years. The company has a market capitalization of $105 billion and a debt to equity ratio of 153%. The stock has a very impressive yield of 5.4%. In this article, we will examine the company's fundamentals and perform a valuation analysis to determine if the stock is cheap at current levels.

Growth:

While net income was down 16% over the last 3 years, the EPS experienced an annual growth rate of 14%. Year over year, EPS was up 63% compared to the 4% increase in revenues. Going forward, analysts expect a long term growth rate of 12.4% on par with the project growth rate of the industry. The growth rates are presented in the table below:


Growth Rates

3 Year

YOY

Revenue

1%

4%

Income

-16%

-6%

EPS

14%

63%

Growth Estimates

VZ

Industry

Next Year

12.60%

-3.90%

Next 5 Years

12.44%

12.22%

Click to enlarge

Profitability and Operations:

VZ's return on assets has been consistent. The company has delivered an ROA of 1% over the last 3 years which is low in my opinion. The return on equity declined from 8% to 6% over the last 3 years. Gross margins last year were 59% and were unchanged during the 3 year period. Overall, I see room for improvement when it comes to operational efficiencies. The profitability and operational metrics are shown below.


Profitability & Operations

3 Year

1 Year

Gross Margin

59%

59%

Operating Margin

13%

12%

Net Margin

3%

2%

Return on Equity

8%

6%

Return on Assets

1%

1%

Click to enlarge

Competition:

To compare VZ to its competitors, key operational metrics for its peers were obtained. The peer group selected for analysis included AT&T (T), Sprint (S), Telephone & Data Systems (TDS) and Cincinnati Bell (CBB). The table below presents the peer analysis results.

Ticker

Market Cap

P/E

P/S

Lt D/E

ROA

ROI

GM

OM

VZ

106.11B

44.19

0.96

139.85

4.53

7.01

58.62

11.62

T

181.78B

46.39

1.44

58.09

1.55

1.77

50

7.27

S

8.06B

NM

0.24

177.35

-5.72

-6.67

43.54

0.22

TDS

3.63B

12.78

0.48

38.6

3.15

3.87

60.6

7

CBB

734.80M

102.84

0.51

0

0.69

0.79

53.69

17.74

Average

51.6

0.7

82.8

0.8

1.4

53.3

8.8

Click to enlarge

As shown above, VZ appears cheap compared to its primary rivals (T and S). I would have preferred a lower debt to equity ratio, similar to that of AT&T .

Valuation:

Valuation analysis was performed using two methods: relative analysis, and residual income method. For relative valuation, the multiple used below was developed based on peer and broader market growth rate and multiple analysis. The relative valuation results are shown below:

Valuation

VZ

Next Yr Proj EPS

$2.78

EPS Growth Rate

12.4%

Future EPS (5 Yr)

$4.19

Expected P/E

15

Price 5 Yrs Out

$62.86

Unlevered Beta

1.06

D/E Ratio

153%

Current Tax Rate

35%

Levered Beta

2.12

Risk Free Rate

2%

Risk Premium

6.00%

Size Premium

-0.36%

Cost of Equity

14.3%

Fair Value

$33.31

Current Price

$32.85

% Overvalued

-1%

Click to enlarge

As shown above, relative valuation results indicate that the stock currently trades at its fair value.

Valuation analysis was also performed using residual income method with an analysis period of 5 years. The long term growth rate of 12.4% was also used as part of this analysis. The results are presented below.

Analysis results

  • EPS 2012 - $2.5
  • EPS 2017 - $4.2
  • Long-Term Growth Rate - 12/4%
  • Terminal Growth Rate - 3%
  • PV of Residual Income = $6.1
  • PV of Terminal Value = $17.9
  • Existing Book Value = $12.7
  • Intrinsic Value = $36.7

As shown above, the fair value for VZ based on residual income based model is $36.7 a share. Taking an average of my relative valuation and residual income based valuation, my fair value estimate of $35 is obtained. Including dividends, a return of 12% is possible. I would wait for VZ to trade at $30 levels before initiating a position in VZ.

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

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.