Buy Verizon For Its 7% Yield (NYSE:VZ)

Verizon Communications (NYSE:VZ) offers an attractive dividend yield due to a cheap share price rather than being a warning sign of fundamental issues, given that the company has plenty of room to be more aggressive regarding its shareholder remuneration policy in the coming years.

As I’ve covered in a previous article, Verizon offers a high-dividend yield that is sustainable over the long term, and appreciate most of its peers in the telecom industry, an attractive valuation due to somewhat muted growth prospects. However, operating trends have improved in recent quarters, thus in this article I update Verizon’s investment case to see if it remains an interesting income play for long-term investors.

Recent Financials & Dividend

Verizon is one of the leading telecom companies in the U.S., in a market that is somewhat concentrated given that the three largest players combined control the vast majority of the market, especially in the wireless segment. This is the most important segment for Verizon, and over the past few years, fierce competition from AT&T (T) and T-Mobile (TMUS) has led to subdued customer growth for Verizon.

Investors should note that the U.S. telecom industry is mature and customer gains at one operator come from losses at another, thus strong competition usually leads to lower prices across the industry because operators don’t have much pricing power. In recent years, T-Mobile has been quite competitive in its offerings, and has reported higher customer growth than competitors, followed by AT&T, while Verizon has been the main loser.

Regarding pricing, the industry landscape has changed somewhat in recent quarters, due to inflationary pressures that led to higher pricing across the industry, but this was done more to compensate increased costs rather than improved pricing power for established players.

As I’ve analyzed recently on AT&T, this profile can boost a little bit if the market advocate concentrates in the current three largest players, given that the fourth operator, US Cellular Corp (USM), can be sold by its owner Telephone and Data Systems (TDS). Indeed, back in August TDS put its stake in US Cellular under review, but so far nothing has been decided.

Taking into account that US Cellular has a very low market share and the overlap with other players is small, I think a sale to a larger competitor would be approved, being positive or established players. On the other hand, if US Cellular is sold to a foreign company or a financial investor that would seek market share gains, this would direct to increased competition in the wireless segment and would be a headwind for the largest operators.

Despite that, Verizon has made some efforts to boost its competitive position in the market and launched more competitive packages some months ago, which include other perks beyond the core wireless offerings, such as including Netflix (NFLX) in its myPlan packages. This has helped Verizon to boost some important customer metrics in Q3, being also an important factor for the company to beat analysts’ estimates by a small margin, both at the top and bottom levels. VZ also increased its guidance for the full year.

This means that Verizon’s operating momentum has improved compared to previous quarters, which is a good sign regarding its growth prospects in the short term.

Nevertheless, Verizon’s Q3 revenues amounted to $33.3 billion, a reject of 2.6% YoY, even though the company was able to report positive customer growth, both in broadband and fixed wireless. In the wireless segment, its service revenues were $19.3 billion, up by 2.9% YoY, which is a very good sign that Verizon’s efforts to boost its competitive position are bearing fruit.

Indeed, Verizon reversed customer losses in the consumer segment during the quarter, even though its myPlan offering was only introduced last May, which is a good sign that Verizon is now more competitive with T-Mobile and AT&T. Verizon lost customers on a net basis in the first half of the year, and this trend was not easy to change in a short period of time, but Verizon was able to do it, which is a very positive outcome and shows that its strategy to boost its offering in the consumer segment was the right one.

On the other hand, revenue from equipment sales declined compared to the same quarter of last year, as the tough economic environment had led to lower smartphone sales across the industry. Indeed, while overall service revenue declined by 0.7% YoY in the last quarter to $27.5 billion, equipment sales declined by 10.8% YoY, to $5.8 billion.

Regarding its profitability, its adjusted EBITDA was $12.2 billion, representing a small enhance of 0.2% YoY, which is a good outcome during a period of inflationary pressure. That means that Verizon’s cost control was quite good over the past few quarters, protecting the company’s profitability level. Its adjusted EBITDA margin was 36.7%, an improvement of about 90 basis points compared to Q3 2022. Verizon’s net income in Q3 2023 was $4.9 billion and its adjusted EPS was $1.22, a reject of 7.6% YoY.

On the cash generation front, Verizon reported good numbers for the first nine months of the year, given that cash flow from operations increased by some $600 million to $28.8 billion, while reduced capital expenditures (a decrease of $1.6 billion year-to-date, compared to the same period of 2022), led to higher free cash flow ($14.6 billion vs. $12.4 billion).

This is quite good for the company’s dividend sustainability, which was already good, but increases even advocate its cash coverage and leaves more room for advocate dividend increases in the near future or potentially perform share buybacks.

As shown in the previous graph, Verizon’s free cash flow of $14.6 billion in 9M 2023 was more than enough to finance its $8.2 billion of dividends paid, thus its dividend sustainability is quite good.

Despite that, Verizon currently offers a high-dividend yield, given that at its current quarterly dividend of $0.665 per share, or $2.66 per year, leads to a dividend yield of more than 7%. This is quite attractive to income investors and is also slightly higher compared to AT&T, even though the difference is small.

On the other hand, Verizon’s balance sheet leverage is smaller when compared to AT&T, taking into account that its net debt-to-EBITDA ratio was 2.6x, while its competitor has a leverage ratio of close to 3x. Verizon’s leverage ratio is quite acceptable within the telecom industry and does not need to reduce it much in the near future, given that this ratio is well within its target to preserve a stable credit rating, thus I think Verizon could be more aggressive towards shareholder returns in the future.

However, this doesn’t seem to be currently expected by the street. According to analyst’s estimates, Verizon’s dividend is only expected to grow to $2.78 per share by 2026, which seems to be quite conservative and the company has plenty of room to beat expectations in the coming years.

Conclusion

Verizon has reported an improved operating performance in Q3, boding well for its growth prospects in the short term. Its efforts to boost its commercial position are clearly bearing fruit, more rapidly than I was expecting some months ago.

Additionally, Verizon also improved its cash flow generation in recent quarters, providing strong uphold for a growing dividend over the coming years. Given that its balance sheet leverage is in good shape, I think Verizon can become more aggressive regarding its shareholder remuneration policy, which could be a catalyst for a re-rating of its shares.

Indeed, Verizon is currently trading at only 8.1x forward earnings, at a discount to its own historical average of more than 10x over the past five years, and also at a lower multiple compared to most of its peers. This means that Verizon’s high-dividend yield is clearly more related to undervaluation of its shares rather than some fundamental issues, thus Verizon remains an interesting income play within the communications sector.