Verizon: Deep Recession Value Ahead Of Q2 Earnings (NYSE:VZ)

Day 2 - GSMA Mobile World Congress 2019

David Ramos

Verizon (NYSE:VZ) is gaining momentum with its 5G roll-out and customer adoption of new products is accelerating. Besides a huge growth opportunity in the 5G market, Verizon has all the attributes of a company that is set to do well during a recession. Since the economy may already be in a recession — and Wednesday’s inflation card showed that growth in consumer prices is ramping up — Verizon’s telecom assets and cash flow predictability make the firm an attractive recession play!

Are we in a recession or not?

Possibly. US gross domestic product decreased at an annual rate of 1.6% in Q1’22 and a second consecutive decline in the GDP growth rate would officially put the economy into a recession. Preliminary Q2’22 GDP estimates will be revealed on July 28, 2022 but analysts expect, at the very least, a material slowdown in economic growth in the second-quarter. Goldman Sachs just down-graded its forecast for Q2’22 GDP growth from 1.9% to 0.7% and considering that inflation roared 9.1% higher in June, economic growth could have slowed down dramatically.

Whether or not the US economy is already in a recession, or just on the brink of one, is not a cause for concern for Verizon investors, however. This is because Verizon’s customers use and will continue to use the company’s services in every market which helps create a stable demand outlook for the firm and its shareholders.

Upcoming Q2’22 results

Verizon is expected to report earnings in three days with predictions calling for $1.33 per-share in normalized EPS, implying a 3% year over year decline. More important than the EPS figure, however, will be an update about the progress of Verizon’s 5G roll-out. Upbeat guidance about Verizon’s 5G expansion as well as strong free cash flow could result in an up-move for shares of Verizon.

Verizon Q2 FY22 Estimates

Seeking Alpha

5G opportunity and low single-digit revenue growth

Verizon’s Consumer Group sees the biggest momentum right now. The Consumer Group provides, as the name implies, consumer-focused communications services and products and the firm’s wireless service revenues are up-trending strongly. The momentum in Consumer Group revenues is due to investments in Verizon’s 5G network that is starting to pay due to growing customer adoption. For example, Verizon’s 5G Ultra Wideband network covered 113M people in the United States at the end of Q1’22. By the end of the year, the company expects to cover at least 175M, implying 55% growth within the year.

Verizon’s total Consumer Group segment revenues soared 10.9% year over year to $25.3B because of strong wireless service revenue growth and because of the inclusion of TracFone Wireless — a prepaid wireless brand that was recently acquired by Verizon — whose financials were included in Verizon’s financials for the first time in Q1’22. Verizon’s consolidated revenues, on the other hand, only increased 2.1% year over year to $33.6B.

Verizon Total Revenue And Wireless Revenue Growth

Verizon

Verizon’s FY 2022 forecast indicates only 1.0-1.5% service and other revenue growth, but 9-10% growth in wireless service revenues.

Verizon FY 2022 Guidance

Verizon

Revenue estimates indicate that the market continues to expect marginal consolidated top line growth of 2-3% annually over the next five years.

Verizon Top Line Growth Estimates

Verizon

Deep free cash flow value

While revenue growth is clearly important for Verizon, I believe free cash flow represents the actual value for the telecom and its investors. Verizon generated $1.0B in free cash flow in Q1’22 with FCF decreasing by $4.2B year over year. However, the decrease was largely attributable to a $2.9B decrease in operating cash flow which resulted from higher inventory levels because of supply chain problems as well as higher receivables.

Verizon Q1'22 Results

Verizon

Going forward, Verizon is set to see a normalization of its free cash flow situation. For FY 2020 and FY 2021, Verizon posted annual free cash flows of $23.6B and $19.3B which calculates to an average quarterly free cash flow of $5.4B. With supply chain problems out of the way and 5G adoption accelerating, Verizon could generate even higher free cash flow in FY 2023.

Assuming that Verizon’s base level of free cash flow is about $22B annually and that 5G customer adoption will continue to grow, then the telecom may generate up to $25B in free cash flow in FY 2023. This calculates to a P-FCF ratio of 8.6 X. AT&T (T), Verizon’s biggest rival, has guided for $20B in free cash flow in FY 2023 which implies a P-FCF ratio of 7.4 X. Both telecoms are cheap based off of free cash flow.

Attractive 5% Yield

Shares of Verizon have a 5% yield and the firm is raising its dividend every year. Between FY 2017 and FY 2021, Verizon increased its dividend by 2.1% annually and investors can look forward to continual dividend growth in the years ahead. Verizon’s dividend is also very safe with a payout ratio of approximately 50%. The firm currently pays a total dividend of $2.56 per-share annually. A 2% dividend increase next year would raise Verizon’s dividend yield to 5.1%.

Verizon dividend yield
Data by YCharts

Risks with Verizon

Verizon doesn’t generate a whole lot of consolidated revenue growth, but 5G is set to grow quickly as consumers upgrade their smart phones to the newest and fastest technology standard. Because Verizon’s customers can be expected to keep using their cellphones and broadband connections during a down-turn, Verizon is not at risk of seeing a drop-off in free cash flow. Stable demand patterns strongly support Verizon’s cash flow and 5% dividend.

The biggest risk, for Verizon, as I see it, is a decline in margins due to growing competition in the 5G/broadband market longer term. This is not a threat to Verizon right now, but it poses a long term challenge to Verizon’s business and it could result in weaker free cash flow as well as a lower valuation factor.

Final thoughts

Verizon represents deep recession value for investors that are worried about how a recession could impact their investments. Verizon is growing rapidly in the highly attractive 5G market and benefits from accelerating customer adoption of its 5G Ultra Wideband network. Verizon’s telecommunications assets generate highly predictable cash flow which secures the 5% dividend. Shares of Verizon are cheap based off of free cash flow as well and the risk profile is skewed upwards!

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