A Study of Verizon (VZ)

Streetwise for Sunday, June 11, 2017

Trying to forecast short-term trends on Wall Street is like trying to herd cats, a great idea but one with little probability of success. However, being patient will alleviate market volatility and enable you to benefit from a continual compounding of earnings.

Two companies requiring a high degree of patience are Verizon (VZ) and AT&T (T). When I last wrote about Verizon a year ago, my earnings target for 2016 was $3.95 per share, with a projected 12-month share price of $58. I have not written about AT&T for many years.

How has Verizon done? Earnings for the year came in at $3.87, a bit light of my estimate, while the shares recently closed at $46.44, also a bit light of my forecast.

Verizon’s market position is its key quality. As of the end of the first quarter of this year, Verizon was the leading wireless provider with just over 35 percent of all domestic wireless subscriptions.

And Verizon has always been a cash cow. Although Verizon’s capital expenditures are often quite large, in the past the company’s free cash flow generation has been impressive. On the negative side, its debt load is well over the $116 billion mark and its free cash flow is now negative.

Compounding the bad news, this year Verizon has been the worst-performing stock in the Dow Jones Industrial Average, declining 13 percent.

Nonetheless, Verizon has managed to grow its quarterly dividend for 12 consecutive years, showing a current dividend yield of 4.97 percent and a 12-year average dividend growth rate of 3.44 percent.

Verizon faces challenges from AT&T’s launch of DirecTV Now, an offshoot of AT&T’s 2015 purchase of Direct TV. There is also AT&T’s pending acquisition of content powerhouse Time Warner.

Verizon did acquire AOL in 2015, and is in the process of acquiring Yahoo. The company also launched its own ad-supported mobile video service go90. But it’s facing some hurdles in evolving its digital media offerings. It pushed back the closing date of its Yahoo acquisition, announced in July 2016 for $4.8 billion, to the end of the second quarter of this year.

While it does live a bit on the edge, let’s be clear that Verizon is not facing any short term financial problems, although its long-term debt level could become a concern if the Federal Reserve continues to raise interest rates.

Verizon’s total debt totals $221 billion, which is over 90 percent of its $244 billion in total assets. Yes, telecommunication companies usually carry a large debt load compared to other companies, which could impede its growth going forward.

For example, Verizon could potentially have trouble adding a new major debt offering needed to acquire companies or start new projects. The alternative is to issue new equity in future financing, thereby diluting current shareholders.

One carefully looked at statistic in evaluating companies is economic profit, a measure of corporate performance computed by taking the spread between the return on invested capital and the cost of capital, and multiplying by the invested capital.

Verizon’s economic profit increased from 2014 to 2015, coming in at $15.005 billion as of December 31, 2015. However, it then declined significantly to $5.124 billion as of December 31, 2016.

This past February, Verizon resurrected its unlimited data plan. The move, an about-face after Verizon largely sat out the industry’s price wars, caters to customers who are spending more time watching videos on their mobile devices.†

Days later rival AT&T, the second-largest domestic telecommunications group by number of customers, quickly matched it. As a result, Street analysts have trimmed earnings expectations for both companies, fearing a possible price war.

The intrinsic value of the shares using the ValuePro.net free cash flow to the firm model, with zero percent revenue growth, is $78.68. My 2017 earnings estimate for Verizon is $3.78 per share, with a projected 12-month share price of $51 for roughly a 10 percent annual gain. We will analyze AT&T in an upcoming column.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.

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