What's Next For Verizon Stock After Recent Earnings? Time To Get Bullish

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Verizon Communications Inc (NYSE:VZ) hasn’t been immune to the stock market selloff with shares down by more than 10% just over the past month. Beyond concerns of a potential economic slowdown and rising interest rates, the company reported mixed results from its latest quarterly earnings. Soft guidance from management hasn’t helped sentiment which explains the weakness in the stock.

That being said, we see value in VZ with several factors supporting a more bullish position at the current level. We like the “defensive” aspect of the company and wireless business. The attraction of Verizon is its cash flow quality which should be relatively resilient in an economic downturn. This is a great opportunity to buy or add to a position with shares yielding 5.6%.

Did Verizon Beat Earnings?

Verizon reported its Q1 earnings on April 22nd with non-GAAP EPS of $1.35 which matched the Wall Street estimate and compares to $1.36 in the period last year. Total revenue of $33.6 billion was up 2.1% year-over-year and also in line with the consensus.

source: company IR

The story this quarter was an ongoing recovery compared to pandemic disruptions in 2020 and the start of last year. Wireless service representing nearly 55% of total revenue climbed 9.5% year-over-year as a strong point from the results. This includes an 11.2% growth on the consumer side as well as momentum on the business wireless with 2.1% growth driven by small-and-medium-sized businesses adding activations.

Verizon also posted 229k total broadband net additions, the best quarter in over a decade, benefiting from the launch of “C-band” as a mid-range 5G wireless coverage technology. This follows the company’s “Network-as-a-Service” strategy integrating mobility, broadband, and cloud solutions. The plan remains on track.

source: company IR

On the other hand, weakness in enterprise and public sector groups has dragged the results with total revenue in the business segment declining by -0.9% y/y. This reflects a more structural trend over the last several years with the loss of fixed “wireline” business services with companies transitioning to wireless and cloud alternatives.

The adjusted EBITDA in Q1 at $12.0 billion fell by 1.1% y/y with a firm-wide margin of 35.9% down compared to 37% in the period last year. Again, several moving parts here, but management noted inflationary cost pressures adding to expenses in everything from network operations, transportation, and the tight labor market.

In terms of guidance, the big headline was a revision lower to the 2022 outlook for “service and other revenue” growth to approximately flat for the year compared to the prior target of a range between 1% to 1.5% of growth. During the earnings conference call, the explanation was the combination of lower “FUSF rates” against a stronger 2021 and softer wireline trends this year.

Nevertheless, management still believes it can reach the targets established earlier this year including adjusted EBITDA growth between 2% and 3% on the strength in wireless. The guidance for 2022 EPS is between $5.40 to $5.55 compared to $5.39 last year, while noting that the final result should be on the lower end of this range.

source: company IR

What To Expect After Earnings

The market’s initial reaction to the earnings report was a selloff, pushing shares to what is currently a four-year low. Understandably, it’s hard to get excited about flat earnings growth and softer guidance. The stock is trading at around $46.00 per share and is down 22% from its 2021 high, and it’s also approaching a level not seen since 2012.

Some of this considers the historically volatile market. The S&P 500 (SPY) fell nearly 10% in April with indications that the momentum in the economy from the initial post-pandemic recovery is slowing in an environment where the Fed is being forced to hike rates. There is a case to be made that expectations got ahead of themselves in early 2021 which stretched valuations that are now getting rolled back.

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The main message we have today is that beyond the near-term volatility, Verizon is operationally and financially sound. We believe that further downside from here will be limited also considering what appears to be a strong area of technical support.

From a high-level perspective, the stock suffered over the past decade from the trend of tepid growth facing intense competition within wireless. A series of failed investments including “AOL” and “Yahoo” simply dragged earnings. The good news is that since exiting the “Verizon Media” business, the company has gone back to basics to re-focus on its core strengths as a telecom leader. We see this as a winning strategy going forward.

In the current environment, telecom can represent a defensive sector. The way we are looking at Verizon is that its wireless service including broadband options has evolved to represent a necessity for the majority of its customers. With the increasing importance of staying connected and mobile applications, there is a component to the business that is counter-cyclical. This means even in a recession; the average Verizon customer is more likely to cut off some other category of discretionary spending before pulling the plug on their Verizon bill. Fundamentally, this supports good visibility for cash flows as a measure of quality in the stock.

To be clear, a deteriorating economic growth environment would still pressure the business. Still, we argue that Verizon will be less sensitive to changes in consumer and business spending. By this measure, shares of VZ can still play a defensive role within a portfolio and should find a bid sooner rather than later.

VZ Dividend Is Safe

Verizon stands out with its 5.6% dividend yield which is one of the largest among S&P 500 companies. The company last hiked the quarterly rate in Q3 2021 to the current $0.64 per share, the 15th consecutive annual increase. The annualized payout of about $10.8 billion per year compares to the company’s free cash flow at $10.4 billion over the past year and also the 2022 company guidance of adjusted EBITDA approaching $12.1 billion.

Data by YCharts

While Verizon is distributing around 100% of free cash flow, this level is set to improve going forward providing more financial flexibility. Within the company Capex plans through 2025, the understanding is that 2022 is particularly Capex intensive including the “C-Band” deployment. Management believes declining Capex requirements can generate $20 billion to $22 billion in free cash flow annually by next year, thereby reducing the dividend payout ratio to a more manageable 50% of free cash flow. In other words, we view the dividend as well supported by underlying cash flows.

source: company IR

What Is Verizon’s Long-Term Outlook?

According to consensus, the market is forecasting Verizon’s revenue growth to average around 2.5% per year through 2025. On the earnings side, while the EPS estimate of $5.41 for this year is just 0.4% above the 2021 result, the expectation is for a rebound higher above the top-line trends with an improvement in margins. One of the drivers is an expectation that the investments in the network infrastructure including 5G can support a trend of higher average revenue per wireless user “ARPU” which reached $30.89 on the consumer wireless side helping the company extract more value from the service.

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It’s important to step back and recognize Verizon’s critical role as the network backbone that powers many of the most important trends in the broader economy. While themes like cloud integration, mobility, and the “internet of things” haven’t been in vogue amid the technology sector selloff, the bullish case for Verizon is the growth is still in the early stages. The company is well-positioned to benefit from the entire ecosystem that includes tech, communications, and media leaders. We view the long-term outlook as strong.

source: company IR

As it relates to valuation, the selloff has worked to bring down shares to a historically cheap earnings premium. VZ is trading at a forward P/E of 8.5x which compares to a 12.5x average for the multiple over the last 5-years. Similarly, the EV to forward EBITDA ratio of 7.0x is also below the 5-year average closer to 8x. The company’s high debt level into rising market interest rates is one reason for the discount, but we believe the stock is simply undervalued with the market unjustifiably too pessimistic. It’s also worth mentioning that VZ has historically rallied when the dividend yield crossed above 5.5%, further making shares look cheap.

source: YCharts

Is VZ Stock A Buy, Sell, Or Hold?

We are bullish on VZ and rate shares as a buy with a price target for the year ahead at $57.50 representing an 11x multiple on the current consensus 2022 EPS. With the dividend yield, our price target implies a total return potential of nearly 30% which is a good reward to risk setup. Steady earnings over the next few quarters could be enough to build confidence in the stock and improve momentum into a sustained rally.

Overall, Verizon is a market leader and an attractive option for income investors. The main risk to consider would be weaker than expected trends from the wireless group forcing a reassessment of the long-term earnings outlook. Monitoring points in the next quarter include the churn rate as well as the operating margins.