Verizon: Surviving but Not Thriving

Verizon Communications (VZ) released quarterly earnings that were up 15%, and while that sounds like an outstanding quarter its not exactly as that headline suggests. As so often happens, the bottom-line has been finessed a bit because of one-time charges. When excluding the one-time charges, earnings dropped slightly from $.62 in this quarter last year to $.61 in this quarter. The company was inline with consensus estimates, and was able to increase revenue by 3.4%. We are not saying that Verizon should be ashamed of that quarter, as more than 50% of companies are not meeting earnings estimates these days, but according to Yahoo! finance VZ’s earnings estimates have been revised downwards twice in just the last 30 days. It appears that the bar was eventually lowered to the correct level at least for this company.VZ Ockham ratings chart

VerizonVerizon did see growth in some key metrics. The Wireless division was again a bright spot as the company gained subscribers. Since merging with Alltel, Verizon has become the nation’s largest wireless provider. Furthermore, the company was able to raise the ever important average revenue per customer for the 11th straight quarter. This speaks to the trend of customers utilizing a data package for the smart phones and blackberry devices that are more popular than ever. Also, Verizon’s FiOS business experienced nice growth and reported record revenue and subscribers. The FiOS division, a still relatively new initiative, definitely has growth potential as it is becoming available to more people geographically all the time, and it has the potential to grab clients from traditional cable and internet providers. The growth in high quality customers (from smart phone users to FiOS customers) helped Verizon improve operating margins by about 350 basis points from last year. These are pretty impressive numbers for an economy in contraction.

Their wireline or home phone business showed further signs of weakness. The home phone is on its way out for so many people, as cell phones have customers connected at all times and the wireline connection just seems redundant. With everyone looking to cut out unnecessary expenses, we don’t see that trend slowing down. Although, Verizon did not announce any job cuts in this earnings release (thank goodness, after yesterday), they had previously announced that they would be shrinking the wireline division by 2,700 workers.

Aside from the slowing wireline business, although Verizon did grow its wireless business it was about 200,000 subscribers short of estimates. Furthermore, the churn rate was up by more than 10% from last year. Last year, the churn rate was 1.2% but it has risen to 1.35%, which may seem insignificant but it may show that Verizon’s industry best churn is starting to revert to industry averages. Some of the blame can be placed on AT&T (T) which is has exclusivity to the extremely popular iPhone (AAPL). Verizon hoped to stem the flow of people leaving for the iPhone by introducing the Blackberry (RIMM) Storm. Verizon choose to keep the sales of the Storm out of the report, which probably means sales were weaker than hoped. Although Verizon’s operating chief thinks that the additional churn was from corporate layoffs and a slowing economy rather than from retail clients preferring other carriers, which seems to make sense.telecom Ockham ratings chart

TelecosAfter the release the stock is off nearly 5% at the time of posting, which suggests that Verizon simply meeting lowered expectations was not all that impressive. At Ockham, we downgraded our rating of VZ to Overvalued as of this week’s report. The stock is not nearly as cheap as a lot of the other high-quality stocks in this market. When specifically looking at the telecom sector, Verizon is one of our most negatively rated in that sector. When looking at Verizon currently compared to how the market has treated them in the past ten years, it is clear that the company is not very attractive relatively speaking. Historically, Verizon has brought in a price-to-sales in the range of .63x to .92x, and the current price-to-sales is in the high end of that range at .85x. Price-to-cash is similar; the current 3.81x is even higher than the historically normal range of 2.57x to 3.73x. In this market environment that is saying quite a bit. So, while we see the 6% dividend yield is appealing, we are not willing to overlook our valuation simply for the income portion, and results from the past quarter were mixed.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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