Verizon: Riskier Than You Think, If Price War Erupts

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Paul Franke
16.35K Followers

Summary

  • Verizon is in danger of falling dramatically in price if a deep recession is next, with the economy hurting from rising inflation and interest rates.
  • Excessive debt levels vs. the wireless industry and other sectors of the stock market are worrisome.
  • Rising interest expense on $153 billion in debt, and spiking worker wage costs are major headwinds going forward.
  • The technical trading momentum picture is stagnant to bearish.

Verizon Wireless

LPETTET/iStock Unreleased via Getty Images

Total returns from Verizon (NYSE:VZ) have been incredibly subpar for years, and things could be about to take a turn for the worse. I have not written a bullish Verizon effort on Seeking Alpha over my time on the platform, measuring almost nine years. Absent the 4% to 5% dividend yield annually, the stock price is exactly where it stood in 2013, creating weak total returns against the +12% annualized gain in the S&P 500 index. I did author a bearish rating on the stock in November 2016 here at $51 per share vs. a flat $51 quote currently, six years later.

VZ stock total return

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Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B) liquidation of the vast majority of his Verizon stake in early 2022 has convinced me to analyze/research the name again, with this quick review of its setup in June being the end result.

Many analysts and investors believe Verizon is a sound and conservative income choice in early 2022. A background buy argument is the stock may be a recession-proof position that holds up during bear markets. That view is tempting to believe, and somewhat supported by historical research. However, it may not apply to Verizon going forward.

Here’s why I do not own shares and suggest others rethink ownership.

My worry is Verizon’s monster debt load with rising interest expense will not mix well with an overall sales decline (or slower than inflation increases). Another worry is escalating union wage costs are coming. Some 30,000 employees are covered by union contracts out of 118,000 in total, with high-end worker benefit and wage costs. Just six weeks ago two Verizon stores in Seattle voted to join a union. The company will likely be required to raise wages closer to the 8% CPI rate annually to keep networks up and running in the future.

If anything has changed since my bearish article in 2016, it would be odds are rising a price war in its commodity-like 4G and 5G wireless offerings could be at hand. Prolonged weakness in the U.S. economy and ramping rates of inflation will surely zap disposable income and consumer spending for many Americans. At some point soon, phone carriers are going to see customers switching to smaller, cheaper cell phone providers through government-mandated tag along services on the big three industry networks, plus movement to less expensive 4G or prepaid no-hassle plans at each carrier. It’s also possible family users will reconsider how many phones are necessary, while low-usage customers may bolt smartphones completely in favor of basic call and text offerings. All of the above would be bad news for wireless provider revenue and income numbers.

According to New York Times writer Rob Pegoraro in a March 24th article,

If you haven’t looked at how your current bill compares with what it might be under a new plan or on a new service, you should check now. Despite the recent shift from four national carriers to three, and the transitions from 3G networks to 4G and now 5G, prices have gone down while data allocations have gone up, especially among the dozens of smaller carriers reselling services from the big three.

My analysis screams Verizon margins could fall precipitously, as earnings misses become more routine into early 2023. In an effort to retain customers and sales, competitive pressures from T-Mobile US (TMUS) and AT&T (T) could unleash an industry-wide price war soon. Such a development would crush Verizon earnings, perhaps by 50% into 2024, given a deep economic recession scenario.

Too Much Debt

Total debt and debt to equity are at record high readings today for the company, with both leverage calculations more than doubling over the past decade. Far from a conservative leverage setup in a growing business, Verizon is setting itself up for trouble. The escalating debt level from a capital-intensive, stagnating sales business model is really rotten news for shareholders.

Verizon debt

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The cash flow to debt multiple has been in steady decline since 2013, and free cash flow disappeared last year after its huge $47 billion spend mostly on federal 5G licenses to stay competitive and expand its network coverage.

Verizon CFO to debt and FCF to debt

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Annual trailing interest expense of $3.12 billion on $153 billion in debt has fallen to a company-record low 2% average rate in early 2022. Yes, the ability to issue low-interest debt to date has been one of the tailwinds holding up net operating results during the pandemic. The flip side is spiking inflation to 40-year highs this year will require dramatically more expensive bond/loan rates, assuming the economy does not implode first (which would be a huge negative for wireless access/plan demand). If there's any good news on debt, $110 billion has been financed beyond five years for maturity.

Mathematically, a move back to 2019’s average 4.1% interest rate cost on borrowings would increase yearly costs to $6.3 billion, wiping out approximately $0.75 in EPS, all other variables remaining the same. It’s not hard to imagine/model stubbornly high inflation rates could triple interest costs 10 years down the road closer to 5-6% on average (assuming new debt is required to maintain the operating business) which would slash EPS up to $1.50!

Verizon interest expense

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Debt is not the only financial-based problem for investors. Out of the subset of the largest cell phone providers in the western world, Verizon presently holds the most leverage (including building leases/rents and pension costs), using the measure of total liabilities vs. assets. Granted this ratio is not a major distortion from the wireless communication industry and competitors, but it’s enough of an issue, conservative blue-chip investors should no longer consider this name a safe, recession-proof position in portfolio construction.

The below graph compares Verizon’s leverage to direct competitors T-Mobile, AT&T, DISH Network (DISH) and United States Cellular (USM), plus large foreign wireless providers BCE Inc. (BCE), Vodafone (VOD), Nokia (NOK), Deutsche Telekom (OTCQX:DTEGY) (OTCQX:DTEGF) Orange S.A. (ORAN), Telefonica S.A. (TEF), and Telstra (OTCPK:TLSYY).

Verizon vs peers total liabilities to assets

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Stretched Valuation

When we include Verizon’s massive debt load and combine it with total equity capitalization, enterprise value measurements vs. revenues and EBITDA (earnings before interest, taxes, depreciation and amortization) highlight the stock as on the expensive side of the spectrum for investors to own. You can visualize its extended valuation position vs. peers on the graphs below.

Verizon vs peers EV to revenues

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Verizon vs peers EV to EBITDA

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One of the reasons Verizon is richly valued, and Wall Street seems OK with its subpar growth future, is profit margins overall remain quite high at 15% of sales. My worry is margins have peaked and are entering a prolonged downtrend in 2022.

Verizon vs peers profit margin

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Outside of T-Mobile, the entire wireless sector is currently projected (using consensus analyst numbers) to witness a stagnation in EPS growth after 2021. To me, the existing forecast of flat earnings growth for Verizon, on top of 2021’s capital spending issue on the free cash flow front, are both clear warning signs for investors to put capital in other equity ideas.

Verizon vs peers EPS estimates

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Technical Trading Picture

Below is 3-year graph of total returns achieved by the peer group from the middle of 2019, months before the pandemic hit. Verizon’s performance has been steady to going nowhere, with shareholder gains entirely a function of the dividend.

Verizon vs peers total return

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On an 18-month chart of daily changes, you can review a gradual decline in Verizon’s price, alongside struggles to recapture the 50-day and 200-day moving averages since the middle of 2021.

The majority of momentum indicators I track are not very optimistic about the future. The Accumulation/Distribution Line (marked with a green arrow) and On Balance Volume (drawn next to the blue arrow) are in bearish downtrends.

Plus, the 14-day Money Flow Index has been a terrific oversold/overbought oscillator for some time in this low-beta, slow moving security. I have circled in red past MFI scores around 80. My point is background technical formations are not yet bullish, staying in bearish patterns. Suggesting VZ as a buy candidate today is not supported by any serious momentum data. It represents something of a stab in the dark.

VZ stock moving averages

18-Month VZ Chart, Author Reference Points - StockCharts.com

Final Thoughts

The 5% dividend yield and current coverage ratio from earnings are very enticing against the S&P 500 index equivalent cash distribution rate of 1.4%. However, if worsening income trends appear later this year, the long-term investment and income picture gets cloudy quickly. In a deep recession scenario, Verizon may decide to cut the dividend payout, at the same time as its stock quote is sliding materially lower.

VZ stock dividend

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Investor returns in the wireless carrier field have been difficult to come by for years. The business model of regular service upgrade expenditures, with flat to sliding consumer selling prices, is not exactly conducive to high growth rates for sales or income. Verizon has been able to ride rising wireless user numbers as a demographic trend, inside an expanding economy for years. But this positive macroeconomic environment is changing. Verizon market share has declined from 35% of the U.S. market in 2013 to 29% at the end of 2021. The primary reason for this weakness can be traced back to excessive debt levels holding income and cash flow in check, the lifeblood capital necessary for network buildouts.

On top of the lagging long-term earnings growth trend for wireless companies, a price war caused by an economic recession could send income into reverse for the whole sector. Rising interest expense as inflation spikes in 2022 could also turn into a significant drag on results by 2023. New higher-rate debt issuance to fund capital expenditures, and refinance existing debt, all but guarantee “billions” in added interest cost annually to keep the company running a few years out.

So, the main risks to owning Verizon around $50 are a weaker economy causes subscriber numbers to fall, unless subscription rates are knocked lower (hurting total sales and profit margins), while inflation bumps interest expense and union labor costs considerably above today's level.

The early 2022 wireless carrier position in the economic cycle may be something akin to the video streaming business in early 2021. Extreme competition on plan pricing could be next, negatively affecting stocks in the industry. All the “free” trial deals from online streamers and now falling advertising-based price points for subscription plans are making income generation extremely difficult for everybody involved. Similarly, if one of the big three wireless carriers slashes plan prices, the entire sector is in trouble.

In essence, we could be on the cusp of a worst-of-all-worlds squeeze on profit margins and net income for investors. It may sound crazy now, but modeling earnings of $2.50 per share or lower is not a far-fetched, ultra-bearish fantasy exercise. Warren Buffett seems concerned about Verizon’s long-term future with the decision to liquidate his Verizon position. Maybe you should contemplate exiting also, before earnings misses start rolling in, and the stock begins a more substantial decline in price. I currently rate Verizon a Sell in the low-$50s.

What could change my bearish outlook? Basically, I do not expect a 10% upmove from $50 to $55 in VZ. If technical momentum turns higher, it would likely coincide with the end of the Russia-Ukraine war and/or a decision by the Federal Reserve to pause tightening. Upside is truly limited by its debt holdings, but a negative to bearish investment setting could be put on hold another year.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

This article was written by

Paul Franke profile picture
16.35K Followers
Nationally ranked stock picker for 30 years. Victory Formation and Bottom Fishing Club quant-sort pioneer.....Paul Franke is a private investor and speculator with 35 years of trading experience. Mr. Franke was Editor and Publisher of the Maverick Investor® newsletter during the 1990s, widely quoted by CNBC®, Barron’s®, the Washington Post® and Investor’s Business Daily®. Paul was consistently ranked among top investment advisors nationally for stock market and commodity macro views by Timer Digest® during the 1990s. Mr. Franke was ranked #1 in the Motley Fool® CAPS stock picking contest during parts of 2008 and 2009, out of 60,000+ portfolios. Mr. Franke was Director of Research at Quantemonics Investing® from 2010-13, running several model portfolios on the Covestor.com mirror platform (including the least volatile, lowest beta, fully-invested equity portfolio on the site). As of May 2022, he was ranked in the Top 5% of bloggers by TipRanks® for stock picking performance on positions held one year. A contrarian stock picking style, along with daily algorithm analysis of fundamental and technical data have been developed into a system for finding stocks, named the “Victory Formation.” Supply/demand imbalances signaled by specific stock price and volume movements are a critical part of this formula for success. Mr. Franke suggests investors use 10% or 20% stop-loss levels on individual choices and a diversified approach of owning at least 50 well-positioned favorites to achieve regular stock market outperformance. The short sale of securities in overvalued, weak momentum stocks as pair trades and hedges is also a part of the Victory Formation long/short portfolio design. "Bottom Fishing Club" articles focus on deep-value candidates or stocks experiencing a major reversal in technical momentum to the upside.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: This writing is for educational and informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. Any projections, market outlooks or estimates herein are forward looking statements and are based upon certain assumptions and should not be construed to be indicative of actual events that will occur. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. The author expressly disclaims all liability for errors and omissions in the service and for the use or interpretation by others of information contained herein. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. The author undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional materials. Past performance is no guarantee of future returns.

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