Verizon: 5 Things To Look For In The Upcoming Earnings Release

Summary

• Due to continuing softness in performance, Verizon stock as fallen 20% year to date.
• Wireless connections, sales, dividend payout ratio, and debt levels are the key indicators I look at for the financial health of the company.
• Verizon has a PEG ratio of 4.6, which is much higher than AT&T's PEG ratio of 1.72.

Verizon (NYSE:VZ) stock continues to decline. So far year to date, the stock has fallen by nearly 20%. This isn't surprising, considering Verizon missed first-quarter 2017 estimates by a wide margin, and there are a number of ominous signs that continue to develop. Second-quarter earnings are due in approximately two weeks (July 27th). Here are the 5 key factors that I'll be looking at:

1. Wireless Retail Connections

The majority of Verizon's profits come from its wireless business, but the amount of wireless retail connections declined in the first quarter of 2017.

Data provided from Verizon's annual reports and earnings releases.

If retail connections decline for a second quarter in a row, I'd be concerned it's the beginning of a trend. This is really the driving force for Verizon, so this figure will be a big factor in the stock continuing to plunge or rebounding. Don't forget that Verizon spent 130 billion to acquire Vodafone's 45% interest in Verizon Wireless a few years ago. That deal is what has put Verizon in the weak position they are today (high debt levels and high dividend payout ratio). That deal was a gamble and now looks like a dud.

2. Sales Trend

In the first quarter of 2017, Verizon missed analyst expectations and showed a 4.5% consolidated revenue decline (excluding divestitures and acquisitions). This has been an ongoing trend, given sales declined in 2016 compared to 2015. Verizon is battling two factors that are pushing its sales down. As I mentioned above, retail connections growth is showing weakness. Second, price wars have been going on for years. Earlier this year, Verizon began offering an unlimited data plan to remain competitive with Sprint (S), T-mobile (TMUS), and AT&T (T). It's not yet clear how this unlimited plan will effect Verizon's sales, so I'm curious to see the second-quarter results.

3. Dividend Payout Ratio

As you can see in the table below, Verizon didn't produce enough free cash flow in 2016 to cover its $9.3 billion dividend payment (i.e., this equaled a 181% payout ratio). It was able to make up the difference by selling some of its landline business to Frontier. This trend has continued into the first quarter of 2017.

• Note - I've included "Net Wireless Licenses" in the "Modified Free Cash Flow" calculation. This includes any purchases or sales of wireless licenses. Purchasing (and sometimes selling) these licenses is core to Verizon's business, which is why I've included them.
• Data in the table above and the table below provided by Google Finance.

There's nothing I hate more than a company that can't afford its dividend. Verizon's dividend payment is now a core discussion with leadership and the board, which I don't like. Dividend payments should never shape important executive decisions ever. It would be prudent for Verizon to cut its dividend, but I don't think it will. The company has built up a reputation as a leading dividend provider. Not only are there expectations for the dividend to be paid, but many investors expect the dividend to continue increasing. If the payout ratio continues to be greater than 100%, this is a big red flag.

4. Debt Levels

Verizon's debt levels have ballooned in recent years as a result of acquisitions and free cash flow shortages.

This is where its ballooning dividend payment really becomes a huge factor. Verizon needs to perform well to support their massive dividend payment, which they aren't currently doing. Verizon also only has $4.3 billion in cash reserves. This is almost nothing for a company with a market cap of close to $180 billion. This leaves little room for error, and future free cash flow shortfalls will likely lead to increased debt levels.

5. Yahoo and AOL Acquisition Updates

If there's one potential bright spot for Verizon, it's what it might do with the Yahoo and AOL acquisitions. The company has already announced it is going to cut 2,100 jobs post merger. In the upcoming earnings release, I'm hoping that Verizon will provide updated details on the expectations of these acquisitions.

Conclusion

Despite a lot of negative trends and a stock price that's severely declined this year, Verizon still trades at an expensive multiple. It has a PEG ratio of 4.6, which is much higher than AT&T's PEG ratio of 1.72. An expensive valuation and many concerning trends signal to me that Verizon is not a good stock to buy right now. My core concerns will continue to be the company's weakening sales and the effect it is having on its free cash flow, dividend payout ratio, and debt levels.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.