(Published by Bob Ciura on July 25)
When investors consider buying high-quality stocks, the term "blue chip" often comes to mind.
There is no official definition of what constitutes a blue chip. Our definition of a "blue-chip" stock is a company that has satisfied two criteria.
First, the company in question has an operating history of over 100 years. Second, it pays a dividend with a current dividend yield of at least 3%.
A company with these two qualities possesses a strong brand and durable competitive advantages and demonstrates a commitment to shareholders.
You can see the full list of blue-chip stocks here.
Verizon Communications (VZ, Financial) is a blue-chip stock. The company dates all the way back to the late 19th century to The Bell Telephone Co.
It has an appealing dividend yield of 5.3%. It is one of 405 stocks with a 5%-plus dividend yield.
Verizon has increased its dividend for 10 years in a row, making it a Dividend Achiever. Dividend Achievers have raised their dividends for 10-plus consecutive years.
Business overview
Verizon, in its current form, was created on June 30, 2000, when Bell Atlantic and GTE Corp. came together in one of the largest mergers in U.S. history.
Today Verizon is a major U.S. telecommunications company. Its prized asset is Verizon Wireless, the largest wireless carrier in the U.S.
Verizon’s adjusted earnings per share, which excludes nonrecurring items, fell 3% in 2016, to $3.87, due to a 4.3% decline in revenue.
Still, Verizon remains highly profitable.
The company’s huge profits are the result of its high-quality network. Due to massive investments in its technology infrastructure, Verizon boasts an industry-leading network
Source: May Analyst Meeting, page 11
Unfortunately, conditions did not improve for Verizon to start 2017. First-quarter revenue declined 7% from the same quarter last year and missed analyst expectations.
Verizon experienced its first-ever decline in core wireless customers. Net retail postpaid connections fell by 307,000, including 289,000 in phones.
The good news is, that the company’s decision to offer unlimited data plans helped stem the customer losses about halfway through the first quarter.
Looking ahead, Verizon is aggressively investing in strategic initiatives, which should help the company return to growth in 2018.
Growth prospects
Two major growth catalysts for Verizon are 5G and the Internet of Things.
Last year, Verizon conducted trials of its 5G infrastructure. The company liked what it saw and as a result will initiate a pilot program in 11 U.S. cities in 2017.
Source: May Analyst Meeting, page 14
If all goes well, 5G could be a reality next year. This would be one of the most effective ways for Verizon to reclaim customers that have gone to lower-cost competitors like T-Mobile (TMUS, Financial).
According to Verizon, 5G speeds are 100 times faster than existing wireless technology. Verizon believes the total market opportunity for 5G could exceed $12 trillion by 2035.
Verizon is gearing up for 5G in a big way. It recently acquired Straight Path Communications (STRP, Financial) for $3.1 billion. Straight Path is a major holder of 5G wireless spectrum.
The Internet of Things, or IoT, is a separate catalyst for Verizon, particularly in telematics, which brings together telecommunications with information and communication technology.
Source: May Analyst Meeting, page 28
In 2016, Verizon acquired Fleetmatics for $2.4 billion to expand in these areas. It also acquired Telogis, which boosts its presence in connected vehicles.
The IoT describes connectivity of all devices, including vehicles, and even home appliances. Verizon’s IoT revenue increased 17% last quarter, year over year.
The company is also expanding into other business areas, including content and digital advertising.
It recently announced it will combine the assets purchased from Yahoo (YHOO, Financial) with its existing AOL business to create a new subsidiary called Oath.
Oath will have more than 50 media and technology brands, including HuffPost, Yahoo Sports, AOL.com, Tumblr, Yahoo Finance and more.
Competitive advantages and recession performance
Verizon enjoys a huge competitive advantage, which is that it essentially operates within a duopoly alongside AT&T (T, Financial).
The costs of building a network that could compete with the two industry giants is massive. There are several competitors to Verizon and AT&T, but none that can match their network strength.
T-Mobile is making a lot of noise as it has undercut the industry majors with low-priced unlimited data plans.
Verizon’s long-term competitive advantage remains intact.
T-Mobile has caught up in 4G. But once newer-generation technology rolls out, such as 5G and the Internet of Things, Verizon should once again reap the benefits of its high-quality network.
This barrier to entry gives Verizon considerable pricing power, which helps keep the company profitable – even during recessions.
Verizon remained highly profitable during the Great Recession:
- 2007 earnings per share of $2.34.
- 2008 earnings per share of $2.54.
- 2009 earnings per share of $2.40.
- 2010 earnings per share of $2.21.
The company’s earnings fluctuated over the course of the recession but gradually rose in the years since. By 2013, earnings per share reached $4.00.
Verizon has hit a wall over the past two years, which has caused its share price to decline and valuation to contract.
The good news is, the recent decline in Verizon’s share price, could set investors up for strong returns going forward.
Valuation and expected total returns
Based on 2016 adjusted earnings, Verizon has a price-earnings (P/E) ratio of 11.3. This is a relatively low valuation. The Standard & Poor's 500 Index, on average, trades for a P/E ratio of approximately 25.
Verizon does not appear to be overvalued, which means investors are likely getting a good price for the shares.
Thanks to the low P/E ratio, investors can earn satisfactory returns from Verizon stock moving forward, even if the company does not grow earnings at a high rate.
For example, a breakdown of Verizon’s potential returns is as follows:
- 2% to 4% revenue growth.
- 1% margin expansion.
- 5% dividend yield.
Even with low single-digit revenue growth, Verizon stock could return 8% to 10% per year moving forward, plus any additional returns from an expanding P/E multiple.
Not surprisingly, Verizon’s dividend will make up a significant portion of its total returns.
Investors can expect continued dividend growth from Verizon each year, albeit at a modest rate.
In 2016, Verizon had a payout ratio of 60%, based on the current annualized dividend payout as a percentage of adjusted earnings per share.
Investors can reasonably expect low single-digit dividend growth, in line with recent years.
Verizon generates a lot of cash flow, but it also has a lot of mouths to feed between high capital investment requirements and lots of debt on the balance sheet.
Verizon ended last quarter with $112.8 billion of long-term debt. Paying the interest and principal on this debt over time will lower the company’s ability to raise its dividend at higher rates.
Final thoughts
Verizon has struggled lately as competition is heating up in the wireless industry. Discount competitors are successfully undercutting the industry leaders AT&T and Verizon.
Verizon remains a blue-chip stock. The company is highly profitable with more than enough profit to fully cover its dividend.
Thanks to its internal investments and acquisitions, the company could see a return to growth next year.
As a result, Verizon remains a blue-chip stock and an attractive investment option for income seekers.
Disclosure: I am not long any of the stocks mentioned in this article.
