Verizon: Nothing is over (NYSE: VZ)

An interesting discussion has begun to brew among the many members of our investment group and it centers around a call to start buying Verizon Communications Inc. (NYSE: VZ) stock from $38 to $35. Frankly, the stock has not doing much at all, and is currently in the middle of that buy range. We believe VZ stock is a buy in this range for stability and earnings.

Of course, the macro situation could worsen. There is a ton of competition. Some have been so bold to say “it’s over” because VZ’s stock just hasn’t budged. But that misses the mark in our opinion. Although we tend to try to spot faster moving swing trades, sometimes boring is good. The stable is good. Obviously, the owners of the stock would like it to go back towards $50 per share. Needless to say. However, nothing is over. The stock is another purchase in this range.

I hate to tell you this, but earning 7-7.25% on your investment through dividends is a pretty decent return in a pretty questionable market. While it’s true that the earnings just released were mixed and the outlook was nothing out of the ordinary, we view VZ stock as a good buy in the mid and high $30s. Verizon stocks are also ideal for long-term income and/or compound interest in a tax-efficient account. We also like a call-and-sell options strategy here, particularly if volatility rises again and premiums rise.

Verizon Q1 results in context

Don’t get me wrong, the Street has been on eggshells this earnings season. So far, SP500 (SP500) companies reporting have been significantly stronger than expected. About 80% of companies have exceeded estimates, while 29% have raised estimates for 2023. While the latter is well below average, the key here is that the estimates aren’t really lowered to any great extent. We were more in the camp than the estimates could go down. That possibility could materialize in the second half of the year, but we think it’s safe to say that not all of the Fed’s actions so far have simply crushed the economy. At least not yet.

As earnings season has just begun, concerns remain about consumer guidance and health. This is the first real major week of Q1 earnings reports, aside from reports from banks, which were largely last week. Verizon missed expectations on the top line and was a very slight beat on the bottom line, but the outlook was in line with its last update. Management continues to struggle with churn, but has taken steps to control expenses and increase cash flow:

Our operational and financial results reflect the measures we have taken to improve our performance. Compared to the same period last year, we added more gross postpaid phone additions to our network and increased our operating cash flow and free cash flow.”

Given what we’ve seen from major competitors, we thought Verizon might struggle with margins and revenue by being highly promotional to attract customers. Management has taken pricing action to help drive numbers up, but we are seeing the impact on margins. Revenue was $32.9 billion and was down 1.9% from a year ago. They missed estimates of $740 million.

Comparisons are largely summarized above for Q1. What about revenue generators?

Verizon’s Revenue Drivers in Q1 2023

Thus, revenues fell by $740 million from estimates. This comes despite fairly strong numbers for new customer additions. Wireless postpaid growth increased 5.3% over last year. There was a retail postpaid churn of 1.15%, which remains high and increased from 1.14% in the fourth quarter. Many customer additions were driven by 5G availability and promotions. In broadband, the company saw net additions of 437,000, compared to 417,000 in the fourth quarter, which was positive. Businesses reported 312,000 wireless retail postpaid net additions, of which 136,000 were added to the postpaid phone network, business wireless retail postpaid churn was 1.50%, and wireless retail postpaid phones was 1.16%.

Verizon’s first-quarter earnings outperformance

New customer additions have been decent here, while revenue has been well below expectations. We were surprised to see EPS holding up so strongly that it caused revenue to miss. Analysts were looking for $1.19 and the company hit $1.20 in EPS. However, EPS is down from $1.35 last year. Adjusted EBITDA decreased 1.1% to $11.9 billion. The title is therefore down compared to last year due to the drop in earnings per share. It’s as simple as that honestly.

While revenue and EPS are down from last year, it is clear that the cost reduction efforts that are being implemented have helped. This shortfall could easily have resulted in a significant shortfall. That said, the EPS tends to drop and that’s problematic. Verizon stock cannot rally significantly from here if we have continued quarter-over-quarter EPS declines. Keep in mind this is where debt weighs in as interest charges are up due to higher rates, and CAPEX was $6.0 billion this quarter. A portion of the impacted revenue and cost savings was associated with the shutdown of the legacy 3G network.

That said, we recommend a buy for income here. So what about the Verizon dividend? This is where free cash flow comes in.

Verizon’s free cash flow in the first quarter

When it comes to big names paying dividends, cash flow metrics are key. This helps us better understand the safety of dividends, the potential for upside or downside. Verizon’s performance has the dividend more than covered, but we also want to keep an eye on the so-called payout ratio.

Expenses remain the focus, while EBITDA has fallen. Cash flow from operations was strong at $8.3 billion and increased $6.8 billion last year. Keep in mind that Verizon pays out more each year in the dividend. Dividends paid were $2.7 billion in the first quarter. Free cash flow was $2.3 billion, an increase from $1.0 billion in the prior year quarter. Doing the math, we see that the payout ratio still exceeds 100%, although this is common for the first quarter. However, it has improved significantly from 270% last year. For the year, we expect a payout ratio of 75%.

Keep in mind that the debt burden matters here. Of course, large debt is a predominant risk in a rising rate environment, as interest charges will continue to climb. New debt is more expensive, as is refinancing maturing debt if needed. The company is trying to reduce debt, but net debt is still massive at $132 billion and has increased since the start of the quarter. This translates into a debt to adjusted EBITDA ratio of 2.7X.

Forward view

It was a mixed quarter for Verizon Communications Inc., but we were impressed with improved cash flow metrics and the ability to beat earnings estimates despite a significant revenue loss. The good news here is that the forecast has not been reduced. Revenues in 2023 will be up at a very low number. The forecast for 2023 earnings was reiterated between $4.55 and $4.85. This is still down from EPS’s $5.18 in 2022. This is a notable drop.

So at $37 per share here, that means Verizon Communications Inc. stock is 7.9X FWD EPS at the midpoint. That might sound cheap, but it’s a wider multiple than through much of 2022 due to the declining EPS outlook. Overall, we still view shares of Verizon Communications Inc. as an income buy, especially as the stock approaches $35.