Verizon Communications: Best Of The Bunch And The Market Knows It

In the 1990s, few imagined that Bell Atlantic Corp would lead the telecommunications industry 15 years later. But that's exactly the position in which its successor, Verizon Communications (NYSE:VZ), finds itself. Second-quarter results confirmed the company's dominance.

The telecom giant's second-quarter earnings (excluding one-time gains) came in at $0.73 per share, up 14.1 percent from last year's tally. Wireless revenue climbed 8.3 percent from year-ago levels, while cash flow margins from services approached 50 percent - an impressive feat considering the hefty subsidies that the company pays for Apple's (AAPL) iPhones.

Verizon Communications' wireless business limited customer churn to a mere 0.93 percent in the second quarter. Subscriber growth also accelerated over this three-month period, while investments to extend the availability of its 4G LTE (long-term evolution) network to 30.1 million people in the U.S. set the stage for further gains.

The days when customer attrition in Verizon Communications' wireline business weighed heavily on quarterly results have passed. Second-quarter revenue in this segment increased by 4.7 percent overall and 9.4 percent per customer, with broadband sales outpacing losses in the traditional voice business.

Revenue from Verizon Communications' FiOS network surged by 14.7 percent from year-ago levels, while sales of cloud, data, security, networking and other strategic services to its global business customers climbed by 4.8 percent. These services now account for 57 percent of the division's sales.

The company's second-quarter results are the latest evidence that the firm has transitioned from a traditional phone company to a fully integrated provider of wireline and wireless broadband technology.

We expect Verizon Communications' dominance to continue despite increasing competition, thanks in part to $7.6 billion worth of network investments in the first half of 2013.

There's always the chance that federal regulators could move to loosen Verizon Communications' grip on the U.S. market. These concerns, for example, prompted Canadian regulators to scrutinize the company's push to enter that geographic market.

Other risks include the need to acquire additional spectrum to continue its U.S. growth and the potential for an expensive buyout of Vodafone Group's (VOD) 45 percent stake in Verizon Wireless.

All these factors could weigh on Verizon Communications' results in a future quarter. The stock's biggest enemies right now, however, are a high bar of expectations and an elevated equity valuation.

Lofty Valuation in an Unloved Industry

Shares of Verizon Communications haven't regained the all-time high hit by its predecessor, Bell Atlantic, in the mid-1990s. However, the stock currently trades at its highest price in more than a decade. Although the company is more valuable now than in the 1990s, the share price has come a long way in a hurry.

Source: Bloomberg

The telecom sector has been in the spotlight a bit more than usual, primarily because of SoftBank Corp's (OTCPK:SFTBY) US$21.6 billion acquisition of Sprint Nextel Corp (S), the third-largest wireless provider in the US. Nevertheless, Sprint Nextel's second-quarter results reinforce the considerable challenge that SoftBank faces to right the ship. Although CEO Dan Hesse expects subscriber growth to return in 2014, this outlook appears overly optimistic when you consider the current rate of customer attrition.

T-Mobile US (TMUS) is unlikely to fare much better when it reports second-quarter results in mid-August. The company has eliminated down payments on the smartphones it sells, intending to make up the difference in higher monthly bills. This strategy could stem customer losses in the immediate term and even spur sales, but higher attrition rates could become a problem over the long term.

Meanwhile, pure-play wireline companies find themselves in a desperate race to grow broadband revenue fast enough to offset accelerating defections of customers ditching their home phone. Aside from Consolidated Communications Holdings (CNSL) and possibly Windstream Corp (WIN), none are close to reaching that goal. (See How Safe Are Telecom Dividends? for details.)

The big cable-television companies such as Comcast Corp (CMCSA) still put up strong numbers. But Cablevision Systems Corp (CVC) and other small fry face mounting challenges; further consolidation within this space appears inevitable.

Trading at 20.7 times earnings from the trailing 12 months, shares of Verizon Communications look expensive relative to the S&P 500, which has a price-to-earnings multiple of about 16.

But Verizon Communications deserves a premium valuation in the current environment, and the company's long-term prospects appear sanguine. For these reasons, the firm's dividend reinvestment plan represents an economical, low-maintenance option for investors to build wealth over the long haul.

However, new investors shouldn't pay more than $47.00 per share of Verizon Communications. This threshold is slightly less than the shares' 200-day moving average; if the stock price were to slip below this support, the resulting selling pressure could trigger additional downside. Investors eyeing a stake in Verizon Communications should remain patient and wait for an eventual pullback.

Disclosure: I am long VZ, CNSL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[mjlangky]

VZ apparently is facing litigation in federal court by several unions representing retired employee groups. They claim misuse of pension money by paying corporate operating expenses among other things.I'm just surprised this sort of practice would have caught media attention.

[Robert Syputa]

I agree with your assessment of Verizon's strengths and performance. VZW has shown itself to be both pragmatic in its decisions, including pushing ahead of the industry into LTE development and deployments in 700MHz spectrum while not making life-threatening blunders in acquisitions similar to Sprint's acq. of Nextel Netwrecks.

However a few points: The wireless industry is far from being unloved: We MBA's and the accountants or managers who studied the mundane topics of corporate finance of the ancient era before the year 2000 might not help but reflect on what that course work once taught about financial ratios and such other nonsense. The debt to equity, P/E and many other ratios of that ancient bygone era are now laughable but should remind us that 'love' can show up in mob acceptance of new norms.

As you noted, VZ has a respectably tame P/E and substantially better sales and earnings trends than most all competitors it is compared. Sprint looks like, well , a real stinker with the promise of coming into something of an alignment with the parent company Softbank to result in higher sales, lowering of debt and debt service, and improved margins. I doubt that will come as easily as it had for SB's acquisition of Vodafone Japan: the competitive environment has marched on with time internationally while Verizon and AT&T pose a different set of competitors not so easily caught off-guard as part of an industry liberalization that has taken place in Japan.

However, Verizon might also be viewed as having reached a regulatory grace plateau and early exploitation of LTE that is set to open up to increased competition going forward.