Sometimes, you just have to pick one. When looking at buying a car, you don't say, I'll take this one and that one. When you go out to dinner, you have to choose one meal. Sometimes, when buying stocks, you have to use the same strategy. It's either one, or it's the other. Today, I'm going to examine two telecom giants, and explain why Verizon Communications (VZ) is a better investment than AT&T Inc. (T).
Better Growth Prospects
Verizon is growing faster at the moment, and that's a fact that cannot be disputed. In the first half of 2012, Verizon's revenues were up 4.16% over the prior year's six month period. AT&T posted just 1.04% growth in its top line number.
This is not just a two quarter issue. For the full year in 2012, analysts currently expect Verizon to increase revenues by 3.9%, and see another 3.4% growth in 2013. Analysts see AT&T only posting a 0.3% increase in revenues this year, including estimates currently calling for both 3rd and 4th quarter revenues to decline over their 2011 counterparts. For 2013, analysts see revenues at AT&T up just 1.2%.
On an earnings per share front, Verizon is expected to post a 15.8% rise this year and a 13.3% increase next year. AT&T is only expected to post a 9.1% increase this year and a 7.1% increase next year. In terms of valuation, Verizon trades at 15.1 times 2013 expected earnings, while AT&T trades at 14.3 times. But, based on the higher revenue and earnings growth, that valuation difference doesn't seem like too much. But, as I present more reasons why Verizon is in better shape currently, you might think that Verizon is undervalued when compared to its counterpart.
Verizon has also improved its margins more than AT&T has, as seen from the following table (these are for the first six months of the year). Verizon has actually passed AT&T in gross margins now, is catching up in terms of operating margin, and extended its lead in net profit margins. I always like to favor companies with higher net margins, and while it's not a tremendous difference, Verizon's numbers are higher, and that makes the name more attractive.
*Overall net margins, not taking out net income or net losses from non-controlling interests
A Cleaner Balance Sheet?
Financial flexibility is always good for a company, especially one that you expect to constantly raise its dividend. When it comes to its balance sheets, Verizon has been cleaning its up, as seen from some key balance sheet numbers (all dollar figures in millions in the following two tables).
Verizon now has positive working capital, something we haven't seen at this point of the year in quite a while. Also, its cash and investments balance has risen nicely, which has put its current ratio over 1. The company has also reduced its long-term debt by $1.5 billion over the past year, and has steadily reduced that figure since 2009. I think Verizon investors are in for a nice surprise when Verizon announces its next dividend raise, potentially in the next few months, as the balance sheet is in a much better position than it has been in recent years.
AT&T may be a different story. Its cash and investments pile decreased from last year's Q2 end, and working capital still stands at a negative $10.5 billion. The current ratio still stands under 0.7, and with the addition of more long-term debt over the past year, the debt (liabilities to assets) ratio has risen over 61% again.
The Competitive Environment
When it comes to this space, everyone wants to talk about Apple Inc. (AAPL) and the iPhone. AT&T is selling more iPhones than Verizon, and Sprint Nextel Corporation (S), for now, but will that change going forward? Look at the following table, showing the amount each carrier sold in the past three calendar quarters, in millions.
Verizon saw less of a percentage decline from Q4 to Q1, and although Verizon's Q1 to Q2 percentage decline was slightly bigger, the number of units sold is getting closer. Now, Sprint will be catching up as its unlimited plan is the best out there currently, but I tend to think that Sprint will take away more from AT&T than Verizon. Why? Well, according to a recent study, Verizon Wireless offers the highest ranking wireless network performance. In the end, the network does matter. Apple's new iPhone is expected to be released in about a month, which will certainly provide some big business to all three names.
Dividends and Yield
When it comes to dividends, both of these names are investor favorites as they have been high yield names in the past and continue to increase their dividends. Over the past three years, Verizon has increased its dividend from $0.46 per quarter to $0.50 per quarter, while AT&T has increased its dividend from $0.41 to $0.44 over that time. If the pattern continues, Verizon will increase its dividend when it next declares one, while AT&T investors will have to wait for another quarter beyond that.
The following table shows these two names' current yields as of this date (August 28) over the past couple of years. Both names have seen their yields come down as their stock prices have appreciated. However, Verizon's has come down a little less over the one and three year periods. Since Verizon will probably increase its dividend first, I would not be surprised if its yield overtakes that of AT&T in the next couple of months. As of today, the two names have almost identical yields. Given how Verizon's balance sheet has also been getting stronger in recent years, I do think that Verizon will end up having a larger dividend in the years to come, in addition to stronger revenue and earnings growth.
When Verizon reported its second quarter results, the company's cash flow from operating activities was up more than 20% to $9.3 billion. Average revenues per user were up nicely, and wireless margins were strong. Additionally, the company's capital expenditures for 2012 are expected to be flat to down. That will improve cash flow even more, and as cash flow improves, that frees up more money for dividends. I'm sure investors will like that idea.
AT&T has performed better in recent times, but I think that is about to change, for several of the reasons I've noted above. The following table shows the overall stock performance for each name, adjusted for dividends, over a series of time periods. I've also compared the two names to the iShares Dow Jones US Telecom ETF (IYZ), which broadly represents the US telecom sector as a whole. Verizon and AT&T account for 29% of that ETF's holdings, so I figured it might be worthwhile to throw in.
Now, Verizon only beats AT&T in the 5-year time frame, but investors have still done much better than the overall sector if invested in either of the two giants. Now, part of AT&T's dominance has been due to higher dividend payouts in the past, which give it an extra leg-up. I noted above that I think Verizon's yield might be higher going forward, which could tilt the scale going forward. For example, if you look at the unadjusted performance of these two names, Verizon has done a little better than the table above suggests. Over the five-year period, Verizon's stock is actually up 2.8%, while AT&T is down 5.5%. Even in the three-year period, Verizon is up 37.6% compared to 39.8% for AT&T, which isn't as bad as noted above.
Conclusion - Go With Verizon
The past is the past. AT&T might have sold more iPhones in the past, may have paid higher dividends in the past, and may have had slightly better stock performance in the past, but investors investing today are looking at the future.
For that reason, I would encourage investors to choose Verizon over AT&T if they had to pick one (they are both great investments if you can have both). Verizon appears set for more earnings and revenue growth over the next year-and-a-half, while trading at a very comparable valuation. Verizon has been improving its balance sheet in recent years, leading to positive working capital and a current ratio over 1. Both the extra growth and cleaner balance sheet will provide Verizon the ability to increase its dividends faster than AT&T, which I believe will provide a higher yield going forward. AT&T may have been the better of the two in the past, but I believe long-term investors are better suited with Verizon going forward.