Verizon Communications Inc. (VZ, Financial), the largest telecom carrier in the U.S. with over 114 million subscribers, has been one of the best-performing large-cap stocks in the media and telecom industry over the last several years. Its returns have consistently beaten the S&P 500 and its dividend yield has made it attractive for income investors.
5G benefits are still a few months away
Verizon has gradually transitioned from the star quadrant to the cash cow quadrant of the BCG matrix. Unlike other telecom players, such as T-Mobile (TMUS, Financial), which continue to grow at a healthy pace, Verizon has almost reached its peak in terms of size. This implies investor expectations with respect to returns must also decline over time. When the stock crossed the $60 mark at the beginning of December, JPMorgan downgraded Verizon’s rating from overweight to hold.
The stock has corrected by about 5% since the downgrade, but investors continue to be optimistic as a result of the upcoming 5G launch. It is expected that Verizon 5G will be launched with the new Samsung Galaxy S10 within the next couple of months. On the other hand, Apple (AAPL, Financial) might be delaying their 5G phone launch until 2020. The current scenario indicates it will take a few months for the 5G launch and its revenue benefits to kick in to Verizon’s stock price, so there is no real short-term catalyst.
This pricey telecom stock has seen some gurus trimming their stakes
There is a reason why Verizon has been an outperformer in the media and telecom sector. Over the last three years, while AT&T (T, Financial) was struggling with the Time Warner acquisition, Verizon's management was focused on strengthening its fundamentals.
Earlier this week, the company announced a voluntary separation program, where 10,400 employees accepted an offer to retire. This is one of the many initiatives management is pushing for long-term cost reduction and margin expansion. The current net margin of 24.71%, along with a return on equity of 70.98%, is among the highest across the media and telecom industry. In fact, upon realizing Verizon's price-earnings ratio is 7.49, the immediate conclusion would be that the stock is undervalued.
This is not the case, however. Verizon’s biggest problem lies in the three-year revenue growth rate, which is -1.2%. Despite a rising number of subscribers, the company’s revenues are not growing like AT&T, which has still managed to post positive organic growth despite its own struggles in the entertainment business. T-Mobile is another competitor that has lower margins compared to Verizon, but is growing the fastest with a three-year growth rate of 8.7%.
Management’s strategic acquisitions of Yahoo and AOL have not contributed much to the growth and they have taken a massive write-down on these assets, considering them to be practically worthless. Considering all these factors, Verizon’s enterprise value-to-revenue multiple of 2.7 is certainly on the higher side for a company with flat to negative top-line growth. It is easily among the most expensive telecom stocks in the U.S. right now.
As illustrated in the chart, Verizon’s stock has maintained a constant growth trajectory for the past year despite having a negative revenue growth rate. Further, the rising price has caused the dividend yield to drop to its lowest levels. For a mature company, such a drastic fall in the yield, coupled with no revenue growth, is the first red flag indicating the stock is expected to witness a correction.
Another red flag is the fact a number of gurus, including Mario Gabelli (Trades, Portfolio), Tweedy Browne (Trades, Portfolio) and Arnold Van Den Berg (Trades, Portfolio), reduced their stakes during the third quarter. Barrow, Hanley, Mewhinney & Strauss divested of 9.44 million shares, which is a significant quantity. There has been no insider selling since May or else the stock price would have witnessed a sharp correction already.
Conclusion
There is little doubt Verizon has kept its investors satisfied with its growth as well as its dividend payouts. It is going to be really difficult, however, for the company to maintain this level of return. A temporary correction is expected in the stock price if the upcoming results are not up to the mark. Over the medium term, it would be safe to conclude there is going to be little excitement around Verizon until the 5G rollout, which might take a while. The stock can be held, but it would be unwise to enter at the current level, especially when the yield is at a 10-year low.
Disclosure: No positions.Ă‚
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