On January 8, 2019, Verizon's (NYSE:VZ) stock jumped by almost 3% after management reported strong subscriber numbers for the most recent quarter. This pre-announcement is extremely encouraging news for this large telecom as it heads into a new year. In today's market, I believe that Verizon is just the type of company that investors should be interested in, especially given the increasing possibility of an economic slowdown (I am not in the "recession is coming in 2019" camp, yet) in the next 12-18 months.
Verizon enters 2019 after a year of outperforming both its closest peer, AT&T (T), and the broader market by wide margins.
Looking ahead, however, I still believe that the stock has room to run. Since Verizon is viewed as a defensive, income play, some pundits are concerned about the company's dividend growth prospects. But, if you ask me, this company has the potential to significantly increase its dividend in the years ahead, and the number prove it.
Verizon obviously operates in a capital-intensive industry, so it should come as no surprise that the company has a high debt balance. For example, Verizon's long-term debt has increased by almost 9% over the last three years.
As of September 30, 2018, the company's debt balance stood at approximately $113B, which seems like (and is) a lot of money, but it is important to note that Verizon's debt is scheduled to mature at a reasonable clip over the next four years (the uptick is coming in 2022).
Source: Q3 2018 10-Q
Source: 2017 10-K
And, more importantly, the company's net debt-to-consolidated adjusted EBITDA ratio has actually come down over the last few quarters.
Source: Q3 2018 Supplemental Report
The takeaway: Verizon's large debt balance is a risk factor but I do not believe that it is a significant concern at current levels. Moreover, I believe that the company has the cash flow prospects that should allow for it to service its debt, while also growing its dividend through at least 2021.
Cash Flow Metrics
More importantly, a review of Verizon's cash flow metrics supports the bull case for this income play. For example, the table below shows that Verizon will not only be able to support its dividend but also increase it over the next few years.
|$ - in millions (Nine months ended)||9/30/17||9/30/18||Chg|
|Net cash provided by operating activities||$16,475||$26,244||$9,769|
|Capital expenditures (including capitalized software)||(11,282)||(12,026)||$744|
|Free cash flow||$5,193||$14,218||$9,025|
|Free cash flow after dividends||($1,874)||$6,935||$8,809|
|Free cash flow dividend payout ratio||(36)%||49%||85%|
Source: Q3 2018 Supplemental Report (linked above)
From an FCF standpoint, Verizon is in a significantly better position today than it was at this point in time in the prior year. And when compared to AT&T (T had an FCF dividend payout ratio of 67.8% as of September 30, 2018, as described here), there is a lot to like about Verizon's results.
Verizon's recent dividend growth history is not stellar (less than 3% over the last five years) but it is important to remember that this company has the wiggle room to increase its payout in the years ahead.
The dividend yield based on today's stock price is approximately 4.2% and investors should expect for this rich yield to rise in 2019, as analysts currently expect for the company to report EPS growth of approximately 1% over the next 12 months. Plus, Verizon is expected to report mid single-digit earnings growth over the next 5 years (per finviz), which should allow for management to support a growing dividend.
Verizon's stock is trading at a premium when compared to its biggest competitor, AT&T.
However, let's also notice that both companies are trading at ratios in the single digits based on trailing earnings, which is extremely cheap in the current market environment. Additionally, VZ shares are attractively valued based on its own historical metrics.
Verizon's stock trading well below 10x 2019E earnings is cheap, in my opinion. The company has risks to its story but I believe that the stock is a great long-term buy at today's price.
Verizon's [growing] debt balance and its cash flow prospects are by far the two most significant risk factors to consider/monitor in 2019. If the cash flow metrics deteriorate over the next few quarters, I believe that Verizon's stock will face downward pressure, especially given the fact that the company plans to heavily invest in other areas (e.g., 5G rollout) over the next 12-18 months.
To be completely clear, I believe that Verizon has the capacity to service its debt load while also growing its dividend over the next 3 plus years. The pundits that are concerned about Verizon's dividend growth prospects are missing the story, in my opinion, because this large defensive telecom company has impressive cash flow metrics that are strengthening, in addition to a below-average payout ratio.
The company pays a rich dividend and has a stable business that should help management weather any near-term storms. Additionally, Verizon has several significant catalysts in place (i.e., 5G rollout, and connected devices/IoT) that should help propel the stock price higher over the next decade. Therefore, investors should be excited about what 2019 may bring for Verizon (and its shareholders) so I believe that investors with a time horizon longer than three to five years should consider adding VZ shares on any significant pullback.
Author's Note: I am long both Verizon and AT&T in my R.I.P. portfolio, and I have no plans to reduce my holdings in either company.
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.
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Disclosure: I am/we are long VZ, T. 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.