Verizon: The 'Pay Raise' Was Nice, But There Is More To The Story

Summary

• Verizon recently increased its quarterly dividend by ~2% - i.e., shareholders got a pay raise.
• This telecom company should now no longer be viewed as just an income play.
• I plan to stay long Verizon; how about you?
• Members of my private investing community, Going Long With W.G., can follow this idea, as well as my other top picks with access to my model portfolio. Start your free trial today >>

Verizon (NYSE:VZ) recently announced a quarterly dividend increase of 2.1% (from $0.59 to $0.6025), which brings the stock's forward yield to a rich 4.4%. As a shareholder, I love getting a "pay raise" but, in my opinion, there is a lot more to like about Verizon as a long-term investment than just a slow-growing dividend.

There Are Other Reasons To Stay Long The Stock

Investor sentiment has been a major problem for Verizon and its shareholders over the last few years, and rightfully so, as the company has had to contend with a challenging operating environment due mostly to the ongoing wireless price wars. The AOL/Yahoo! acquisitions did not help either (i.e., investors were not excited about acquiring these digital assets).

I, however, added shares in the upper-$40 range over the last year because I believed (and still believe) that Verizon was being properly positioned for the future, as described in this article.

Source: Q4 2016 Earnings Presentation

While there are currently questions about Verizon's intentions with the digital media assets, especially when considering the potential departure of Tim Armstrong, I still believe that the company is positioned to greatly benefit from the two main growth areas - Internet of Things ("IoT") and Network Leadership.

Moreover, Verizon recently reported Q2 2018 operating results that showed that there are plenty of reasons outside of the dividend to stay invested in this telecom giant. The company reported adjusted Q2 2018 EPS of $1.20 (beat estimates by $0.06) on revenue of $32.2B (beat estimates by $420M), which compares favorably to what Verizon reported in the same period of the prior year.

Source: Q2 2018 Earnings Presentation

Highlights from the quarter:

• The company beat the top- and bottom-line estimates and it reported YoY growth in both revenue and earnings.
• The wireless division reported strong results almost across the board - revenue up 5.5% (to $22.4B), solid service revenue growth of ~1%, 531k net increase in postpaids (369k connected device additions), and segment EBITDA of $10.7B (margin of 47.8%) compared to $9.8B (margin of 45.8%) for Q2 2017.
• Cash flows from operations of $9.3B, which was up $1.9B when compared to Q2 2017.

Management also updated its full-year 2018 estimates: low-to-mid single-digit growth in consolidated revenue, low-single-digit growth in adjusted EPS (net of tax reform and ASC 606 impacts), CapEx at the lower end of the $17-17.8B range, and an effective tax rate at the lower end of the 24-26% range.

Verizon not only reported strong Q2 2018 results, but also, in my opinion, the operating metrics and follow-up management commentary during the conference call showed that the company's long-term story is indeed still intact.

The Main Catalyst

The 5G rollout is, in my mind, the most significant catalyst for Verizon and the other major telecom companies. As described by Goldman Sachs in this investor video, 5G is going to change the wireless industry in a major way.

As Okapi Research described in this recent article, 5G has the potential to be a real game-changer for Verizon. Plus, there are rumors that Verizon is closing in on 5G deals with Apple (AAPL) and Google (GOOG) (GOOGL), which would be extremely positive developments if the rumors turned out to be true. As such, the investments being made today have the potential to greatly shape the way Verizon will be viewed in the market for years to come.

I say all of this to simply say the dividend is not the only reason to stay the course with Verizon. But the dividend does definitely help the bull case though.

Paying You To Be Patient, And The Stock Is Attractively Valued

As described above, Verizon raised its quarterly dividend by 2.1% and now sports an impressive 4.4% yield based on today's price. But, more importantly, VZ has more than enough room to maintain its healthy dividend.

The dividend as a percentage of FCF for the first half of 2018 was 56%, which compares favorably to the over 100% that was reported for the same time period of the prior year. Based on these metrics, the sustainability of Verizon's dividend should no longer be a discussion point.

Lastly, it also helps the bull case that VZ shares are trading at an attractive valuation based on historical metrics.

VZ PE Ratio (Forward) data by YCharts

Let's also not forget that the market is trading near (or at) all-time highs, so the 11x forward estimated earnings is even more attractive than you may think.

Risks

Outside the risk of the wireless price war continuing for an extended period of time, there are several other risks that may change my long-term thesis. There are concerns about the prospects of Oath (and the Armstrong departure), but in my opinion these concerns are short-term in nature.

The number one risk in my book is Verizon's financial leverage. The debt balance is not significant concern right now, but this could change in short order with the infrastructure spending that will be necessary for the 5G rollout.

Bottom Line

Verizon has long been viewed as an income play, but I believe that this company currently has growth potential. Yes, the price wars are having an impact, but in my opinion this should be viewed as a short- to intermediate-term headwind.

I believe that Verizon's management team has done a great job heavily investing in "other" growth areas, so there is a lot to like about the company's long-term business prospects, especially after factoring in the potential benefits of 5G. As such, investors with a time horizon longer than 1-3 years should view pullbacks as long-term buying opportunities.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long VZ. 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.