Dividend Growth Stock of the Month for September 2021: Verizon Communications (VZ)

Verizon Communications (VZ) is a holding company that is one of the world’s leaders in communications, technology, and infotainment products and services to consumers, businesses and government entities.

With AT&T (T) about to reorganize and decrease its dividend, many eyes have turned to Verizon as a similar investment in the same sector with a more stable dividend. Let’s check it out.

Verizon’s Dividend Record

Verizon is a high-yield, slow-growth stock.

Verizon’s most attractive dividend features are its high yield and very safe dividend. Its dividend growth rate, at 2% per year, would be considered too slow by many, while other investors (including myself) are fine with that slow rate in exchange for Verizon’s 4.5% yield.

The safety of Verizon’s dividend is indicated by its 87 / 100 safety score from Simply Safe Dividends. That score was just reaffirmed on August 5 after the company’s Q2 earnings release. Any score from 81 to 100 is in SSD’s top tier of safety rankings.

These graphs from Simply Safe Dividends illustrate that Verizon is not paying out an excessive share of its profits or cash flow. That is a principal reason for its high safety score; the company is in a good place financially for maintaining and increasing its dividend.

Verizon hasn’t announced its dividend increase for 2021 yet. They typically do that with their 3rd-quarter dividend, which last year was announced on September 3.

Business Model and Company Quality

Verizon offers data, video, and voice services around the world. Its networks and platforms are considered to be some of the finest for mobility, reliability, security, and control. It is actively building 5G capabilities along with the rest of the industry.

Verizon reports its results in two segments that it operates as strategic business units – Verizon Consumer Group and Verizon Business Group.

  • Consumer: Provides wireless and wireline communications services and products. Wireless services are provided across one of the most extensive networks in the USA and through wholesale and other arrangements. Wireline services are provided in nine states over fiber-optic and some copper-based networks. In 2020, Consumer segment revenues comprised approximately 69% of Verizon’s consolidated revenues. Consumer has about 94 million wireless retail connections, 7 million broadband connections, and about 4 million Fios video connections.
  • Business: Provides wireless and wireline communications services and products such as data, video, conferencing, and corporate networking. In 2020, the Business segment’s revenues were about 24% of Verizon’s consolidated revenues. This segment has approximately 27 million wireless retail postpaid connections and 482 k broadband connections. Customer groups within the Business segment include small businesses, government entities, and wholesale customers that may compete with Verizon.

Verizon’s strategic focus is on its wireless business and related opportunities. The company has for years marketed itself as providing network quality. It has invested heavily in maintaining and improving its network, and a result of that focus is that it has attracted and retains a loyal customer base.

Verizon holds about 40% of the postpaid wireless phone market, more than AT&T or T-Mobile/Sprint. This scale enables the company to generate the highest margins and returns on capital in the industry. Price wars have diminished since the merger of T-Mobile and Sprint, but the industry remains competitive on price, data usage, and ease of network connectivity.  Verizon has joined its rivals in offering lower rates on its unlimited data plans, which account for about 60% of consumer sign-ups.

Verizon paid more than $50 B in March, 2021 for a large spectrum acquisition that will be important for its buildout of 5G service over the next few years. The purchase doubled Verizon’s mid-band spectrum holdings. Mid-band spectrum has unique characteristics that support both in-building and distance wireless signal coverage that make it highly suitable for 5G network buildout.

Like AT&T (T), Verizon stumbled with its forays into content (AOL in 2015 and Yahoo in 2017). Those have been written down, and the company’s current media strategy is to make alliances with content providers such as YouTube and Disney+ rather than own and run its own content creators.

Verizon has few fixed-line operations left except in the Northeast. It has extensive fiber assets in most major markets that are mainly used for enterprise customers. Verizon is expanding this capacity into more locations to enable it to offer new services.

Financials

Verizon reported second-quarter 2021 results on July 21, registering beats above consensus expectations on both revenue and EPS estimates.

We saw earlier that Value Line assigns its highest Financial Strength rating of A++ to Verizon. They also consider VZ to have the strongest financials among 10 peer companies.

Let’s take a deeper look for ourselves.

Verizon is a slow-growing business. You can see its revenue growth in the graph below. Sales dropped in 2020 because of Covid, but they are rebounding nicely this year, driven by revenue growth in wireless services, wireless equipment, Verizon Fios internet, and digital advertising.

(Source of all graphics in this section: Simply Safe Dividends)

Verizon’s profitability is very good.

Verizon has an excellent record of generating positive earnings year in and year out.

As is typical of telecoms – with their capital-intensive businesses – Verizon carries high debt levels and does not reduce its share count steadily, as it relies on equity financing to help pay for its capital needs.

The jump in Verizon’s debt and share count in 2014 was needed to obtain full ownership of Verizon Wireless, which (it stated at the time) was the best wireless asset in the world. The wireless network is central to Verizon’s business today. Verizon has done a good job cutting its debt since 2014, and it maintains an investment-grade credit rating.

Here is a summary of Verizon’s financials.

I don’t give Verizon the highest financial grade possible, mostly based on its relatively high debt levels and the issuance of shares that accompanies Verizon’s acquisition activities. Those items appear to be well under control, however, and overall I would rate Verizon’s financials as solid.

Valuation

I use four models to value stocks, then average the results. See Dividend Growth Investing Lesson 11: Valuation.

Models #1 and #2: FASTGraphs relative P/Es

The first two models use FASTGraphs.  Model #1 is a basic estimate of the stock’s fair value based on general market history, while Model #2 is based on the stock’s own past 5-year average valuation rather than market history.

The orange line is a fair-value reference line based on Model #1. For Verizon, the orange line is drawn with a P/E of 15, which is a generally accepted “average” P/E for the market as a whole.

The blue line, for Model #2, is drawn at P/E = 12.6, which is Verizon’s own P/E ratio over the past five years.

The black line is Verizon’s actual price, which sits at a current P/E ratio of 10.7. Note how Verizon’s current price is beneath the orange and blue reference lines, suggesting that VZ stock is currently undervalued.

For all of the models, I compute valuation ratios that express the ratio of actual price to fair price. Here is the formula for the first two models:

Valuation Ratio for FASTGraphs = Current P/E divided by Reference P/E

Here are the valuation ratios for Verizon under the two models:

  • Model 1: Based on basic (orange) line: 10.7 / 15 = 0.71
  • Model 2: Based on historical (blue) line: 10.7 / 12.6 = 0.85

Model #3: Morningstar DCF Valuation. Morningstar uses a discounted cash flow (DCF) model for valuation. The idea behind DCF has been summarized by Warren Buffett:

Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. The calculation of intrinsic value … is an estimate rather than a precise figure. (Source)

Morningstar makes what I believe are conservative, logical estimates and performs the necessary calculations. Just as I did with the first two models, Morningstar converts their result into a valuation ratio, which is circled below.

Morningstar’s valuation ratio is 0.97, suggesting that they see Verizon as fairly valued (3% off claculated fair price).

Model #4: Current Yield vs. Historical Yield. The last model compares the stock’s current yield to its historical yield. The idea is that if a stock’s yield is higher than normal, it suggests that its price is undervalued (and vice-versa). This model is akin to Model #2, using yield instead of price to estimate fair value.

Verizon’s current yield of 4.5% is just a bit above its 5-year average of 4.4%. Again I compute a valuation ratio:

Valuation Ratio for Relative Yield = 5-Year Yield divided by Current Yield

The valuation ratio in this case is 4.4% / 4.5% =  0.98, meaning fairly valued.

Valuation summary. This table summarizes the four models:

Simply taking the average of the four leaves us with a valuation ratio of 0.88. Because valuation calculations are inherently inexact, I apply a 10% cushion above and below fair value to define my fair-price range.

At around $55 for its current price and with a yield of 4.5%, I see Verizon as selling at a discount right now.

Analysts’ Recommendations

Many brokerage accounts provide free stock analyses from various data providers. My Dividend Growth Portfolio is held at E-Trade, and one of the independent analyses they provide comes from Refinitiv. They, in turn, publish a standard survey of Wall St. analysts for their recommendations.

The average recommendation of 30 analysts covering Verizon, on a scale of 1 (sell) to 5 (strong buy) is 3.3, which equates to hold. I consider this a neutral factor.

The Bottom Line on Verizon Communications

VZ’s Positives:

  • High-yield, slow-growth stock with safe dividend. Can fill role in DG portfolio to provide reliable dividend income for spending or reinvesting.
  • Good fundamental business model. Telecommunications is a must-have for both businesses and individuals in the current age.
  • Excellent network to support wireless services and growth. Has put content acquisitions behind it to concentrate on core business.
  • Very good financials with exception of debt associated with acquisitions. Debt is being worked down steadily.
  • Complete control of wireless network and business since 2014 has worked out great.
  • About 12% undervalued.

Verizon’s Negatives:

  • Slow – but steady – dividend growth rate.
  • Too high a debt load, although management has been reducing it steadily.

Conclusion: In my opinion, Verizon is a very good candidate for dividend-growth investors who are looking for a high-yielding company with a safe, reliable dividend.

This is not a recommendation to buy, hold, sell, trim, or add to VZ. Any investment requires your own due diligence. Always be sure to match your stock picks to your personal financial goals.

Recent Articles on Verizon

Verizon (VZ) is Perfect for my Dividend Growth Portfolio – So I Bought Some More (Dave Van Knapp, April 2021)

Tara’s Breakout Stock Alert: Verizon Communications (VZ) (Tara Young, September 2020)

— Dave Van Knapp

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Source: DividendAndIncome.com