(Published Feb. 20 by Bob Ciura)
When it comes to the telecommunications sector, one of the things that never changes is the ongoing price war between the major wireless carriers AT&T Inc. (T, Financial) and Verizon Communications Inc. (VZ, Financial).
Virtually everyone in the U.S. who wants wireless, TV and internet services by this point probably has it.
As a result, in order to generate growth in the U.S., the major carriers often resort to taking customers from one another.
This is typically done through price wars, which heated up again recently when Verizon announced it will offer unlimited data plans.
Both Verizon and AT&T are Dividend Achievers, a group of 272 stocks with at least 10 years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
AT&T is also a Dividend Aristocrat since it has raised its dividend for 33 years in a row.
You can see the entire list of all 50 Dividend Aristocrats here.
A renewed price war, however, stands to hurt Verizon more than AT&T. This article will discuss the latest turn in the never-ending wireless war.
Business overview
Going forward, Verizon Wireless customers will be able to purchase an unlimited talk, text and data plan for $80 per month for a single line. The cost per line declines as more lines are added to a customer’s plan, culminating in $45 per month per line for four lines.
Verizon previously resisted the idea of offering unlimited data because of the potential margin erosion.
For many years, Verizon generated industry-leading margins on the wireless side of the business. This was the result of the massive investments it made to build the strongest nationwide network.
Its advantage, however, has been undone in recent periods.
AT&T actually surpassed Verizon in the fourth quarter with a best-ever U.S. wireless EBITDA margin of 45.4%. Its wireless margin expanded in 2016.
Source: 4Q Earnings presentation, page 6
Meanwhile, Verizon Wireless generated a segment EBIDTA margin of 36.9% in the fourth quarter.
Verizon’s wireless margins steadily declined throughout 2016 from the 42.5% wireless margin it held in 2015.
Verizon’s margins are declining because its customers are gradually accepting slower data speeds in exchange for unlimited data and lower monthly bills from its competitors.
Matching its competitors’ unlimited data plans will only pressure Verizon’s margins even further in 2017. That is because it has nearly gone all-in on wireless after the $130 billion acquisition of Vodafone’s (VOD, Financial) 45% stake in Verizon Wireless.
Wireless service now represents the vast majority of Verizon’s total revenue:
- Verizon Wireless (72% of total revenue)
- Verizon Wireline (28% of total revenue)
As a result, its growth is largely dependent on wireless growth.
In contrast, AT&T is more diversified. It has made significant investments in TV, with internal investments in U-Verse as well as its $49 billion acquisition of satellite TV provider DirecTV.
AT&T operates four main segments:
- Business Solutions (43% of revenue)
- Entertainment Group (32% of revenue)
- Consumer Mobility (20% of revenue)
- International (5% of revenue)
AT&T stands to be diversified even further going forward as a result of its pending $109 billion deal for content giant Time Warner (TWX, Financial).
Source: Time Warner Acquisition Presentation, page 6
Time Warner offers cable networks like TNT, TBS and CNN as well as premium networks HBO and Cinemax. Time Warner also operates the Warner Bros. movie studio.
Verizon’s strategy worked wonders during the early stages of 4G rollout. It staked itself out to a big lead in 4G thanks to its network quality, which fueled its high margins and pricing power.
Regardless, most carriers caught up in 4G in 2016.
Verizon’s retail postpaid net customer additions fell 61% in the fourth quarter.
Source: 4Q Earnings presentation, page 9
As a result, Verizon may not reclaim its top-tier margins until 5G rollout.
Growth prospects
Verizon conducted initial trials of its 5G service in 2016, and hopes to be ready for nationwide rollout later this year.
In its 2015 annual report, the company alludes to this with the following excerpt:
“We expect future growth opportunities will be dependent on expanding the penetration of our network services, offering innovative wireless devices for both consumer and business customers and increasing the number of ways that our customers can connect with our network and services.”
Essentially, in order for Verizon’s customers to see the true value of the company’s high-end services, it relies on the most powerful network infrastructure possible.
With the maturity of 4G, even lower-tier carriers have had time to catch up, and their marketing has emphasized that most customers will not notice a difference.
For example, Sprint (S, Financial) has advertised using Verizon’s old “can you hear me now?” spokesman, who states Sprint’s network quality is now within 1% of Verizon’s.
This will likely change once Verizon’s major growth drivers—namely 5G and the internet of things—reach nationwide rollout across the U.S.
Source: 4Q Presentation, page 12
When that happens, differences in network quality will once again become noticeable.
Verizon is still likely to be more adversely affected by a wireless price war than AT&T in the short term, however, given the relative importance of wireless to Verizon’s bottom line.
AT&T’s diversity helped the company turn in excellent growth figures in 2016.
Source: 4Q Earnings presentation, page 8
Verizon has compelling long-term growth catalysts, but its decision to offer unlimited data could have a more severe impact on margins—and consequently dividend growth—in 2017.
Dividend analysis
The biggest impact of a price war is it is generally a win for consumers, but at a cost to a company’s bottom line.
Verizon’s decision to match its competitors’ unlimited data plans is likely to keep pressure on margins, at least in 2017.
Falling margins could also weigh on Verizon’s ability to raise its dividend. This is a concern for investors since its dividend growth rate has recently been slowing down.
For example, the company’s dividend increases over the past few years are as follows:
- 2014 dividend raise: 3.8%
- 2015 dividend raise: 2.7%
- 2016 dividend raise: 2.3%
As a result, Verizon investors should expect a 2017 dividend increase in the 1% to 2% range, while AT&T should be able to maintain its 2% to 3% dividend growth rate.
Final thoughts
AT&T and Verizon have very similar dividend yields, but the latter's dividend growth could decline in 2017 as the telecom price war has reared its ugly head once again.
This affects Verizon more than AT&T.
For investors who desire current income, such as retirees, AT&T and Verizon both remain attractive stocks for risk-averse income investors.
Disclosure: I am not long any of the stocks mentioned in this article.
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