At 6.96%, Verizon Communications Inc. (VZ, Financial) has a big dividend yield, and it would be understandable if you were skeptical. After all, such dividends often come with failing companies and plunging stock prices.
But could that be true of one of America’s top three telecom companies? Could it be a value trap, as the current price suggests?
To answer that question, I will look at the current state of the industry and at Verizon’s fundamentals. Regarding the industry, the following 10-year price chart shows how all three of the top telecoms—AT&T (T, Financial), Verizon and Comcast (CMCSA, Financial)—have lost the confidence of investors:
Why have their stocks been on the outs? Jerome Dodson (Trades, Portfolio) of Parnassus Value Equity Fund (Trades, Portfolio) gave a brief explanation in his third-quarter 2022 commentary on Verizon. He wrote, “Competition within the U.S. telecommunications industry has intensified recently, and the need to invest in next generation 5G technologies is deflating profits for Verizon.”
The battle for market share in the wireline, wireless, broadband and other communication systems is unforgiving. A company that falls behind in its technology and pricing will likely lose market share in the long term, and that has long-lasting financial (and career) implications.
Remember, too, that telecom companies must make these big investments upfront. Only after making the capital investments can they begin recapturing costs and profits. That often takes longer than short-term investors are prepared to wait.
This chart shows how Verizon’s long-term debt has grown over the past dozen years.
Dodson also mentioned consolidation of the industry, and there have been some major deals in recent years. There have been many billion-dollar acquisitions in the years since 1997, but Verizon has made only one in the past 10 years, and that is on the low end of the scale. In 2021, it paid $3.12 billion in cash (with a potential performance bonus of up to $650 million) for TracFone Wireless, the largest reseller of wireless services in the country.
Still, Dodson sees the telecoms regaining their profitability. He said, “Despite these near-term headwinds, we believe the stock offers an attractive risk-reward with a 7% dividend yield. We expect profitability to recover after this investment phase, and the benefits from consolidation of competitors T-Mobile and Sprint should accrue to all wireless players, including Verizon.”
According to an analyst at Morningstar Inc. (MORN, Financial), investors should not expect much growth in earnings over the next couple of years. In 2022, Verizon saw earnings per share of $5.06, down from the $5.32 posted in 2021.
Looking ahead, the analyst sees just $4.63 for full-year 2023 and $4.66 for full-year 2024. In its first-quarter 2023 earnings release, the company estimated that adjusted earnings would be between $4.55 and $4.85.
Relatively flat earnings suggest the share price is unlikely to get much, if any, upward pressure.
How about the other fundamentals? Do they signify much potential?
The GF Score, which summarizes a company’s financial strength, profitability, growth, momentum and valuation, is just 76 out of 100. That’s OK, but far from a strong endorsement.
Looking at the pros and cons, debt would certainly highlight the cons side. Verizon’s interest coverage ratio is 7.5, which, again, is adequate. Its Altman Z-Score, at 1.27, is within the distress zone, though I doubt there is any risk that will not work itself out in the next few years (as capital expenditure declines and profitability increases).
On the con side as well is slow revenue and earnings growth. Revenue has grown by only 0.70% per year over the past three years, while Ebitda growth averaged 3% and earnings per share without non-recurring items averaged 2.90%. None of that makes an investor want to run out and buy shares.
However, there is encouraging news when I examine profitability metrics. The operating margin, net margin and return on equity at Verizon are industry-leading for the telecommunication services space. Its net margin is 15.85%, whereas the industry median is 4.76.ÂÂ
There is also good news in terms of valuation. Verizon’s price-earnings ratio is 7.33, well below the industry median of 15.97. Its PEG ratio is 2.36, which puts it into overvaluation territory. The GF Value Line finds it to be a possible value trap, so potential investors should carefully weight the risks before making a decision.
Because it has a predictability rank of just one out of five stars, it is not considered suitable for discounted cash flow analysis.
But the star on the pros’ side is the dividend. At 6.96% at the close on May 2, the yield will be quite attractive to income investors. It may not quite be a bond substitute, but it is in the vicinity. Verizon is in little danger of financial distress, and it has the potential to start reaping rewards from its heavy investments.
That seems to be the foundation of Dodson’s optimism. He had the second-largest guru holding at the end of 2022, with 3,521,415 shares. It represented a 0.08% stake in Verizon and 2.98% of his fund’s holdings. Diamond Hill Capital (Trades, Portfolio) had the largest position, according to 13F filings, with 6,775,460 shares.
Investors should be aware that 13F filings do not give a complete picture of a firm’s holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
In conclusion, Verizon’s dividend yield may be of interest to income investors, but growth appears to be at least a few years away. As Dodson has suggested, that will have to wait for capex investments to decline and earnings to rise.
