Bruce Bennett
Investors in leading telco company Verizon Communications Inc. (NYSE:VZ) have seen VZ recover remarkably from its March lows, even though its momentum appears to be stalling.
The market had gone into a broad downward de-rating move from its January highs, likely reflecting worse macroeconomic uncertainty and a coming consumer spending slowdown.
As such, it could threaten the buildout of Verizon’s fixed wireless or FWA growth. VZ has gained more than 1M subscribers (and growing) in a retort against arch-rival AT&T’s (T) contention that FWA is a “niche product and won’t work at scale.”
Moreover, Verizon’s approach should see the company leverage its cost competitiveness and leadership as it “holds approximately 40% of the US postpaid phone market.”
Verizon’s scale allows it to compete with AT&T and T-Mobile (TMUS) effectively, as they dominate “90% of the retail postpaid market share in the US.”
However, the growth of FWA is still in the earlier stages, with the company expecting to post nearly “four million to five million subscribers” by 2025.
Despite that, T-Mobile is still the market leader that Verizon is competing against as the company attempts to stretch its lead further, reaching about 7.5M subscribers by 2025.
Moreover, UBS suggests that FWA is “near its peak rate of additions,” indicating that TMUS should retain its leadership over Verizon.
Morningstar cautioned investors that Verizon’s postpaid market share could face more intense competition and is “expected to diminish over time.”
Therefore, we believe the battering that VZ has suffered over the past year is justified as it fell dramatically from the $55 level, still down nearly 30% in price-performance terms.
With that in mind, bullish VZ investors could be satisfied that its valuation has been battered sufficiently for an improved risk/reward profile.
We concur that VZ is no longer overvalued, as its valuation has normalized significantly.
Accordingly, VZ last traded at an NTM EBITDA of 7.2x, in line with its 10Y average of 7x. Its NTM free cash flow or FCF yield of 10.4% implies a considerable discount over its 10Y average of 8.7%.
Coupled with an NTM dividend yield of 6.7% (NTM adjusted payout ratio of 56%), income investors likely aren’t in danger of seeing their dividend slashed in the company’s bid to maintain its margins.
VZ blended fair value estimate (InvestingPro)
As such, VZ’s blended fair value estimate of $47 suggests that VZ seems to be in the fair value zone, leaning toward being undervalued, despite the recent recovery.
Moreover, Trefis’ sum-of-the-parts or SOTP valuation estimate of $44 suggests it’s pretty much in line.
VZ price chart (weekly) (TradingView)
Despite that, we gleaned that VZ had a bull trap at the $43 level from its early January highs that has remained in place as buyers couldn’t mount a decisive breakout of that level post-earnings.
However, buyers returned robustly at VZ’s March lows, likely seeing dislocated valuations. Notwithstanding, its recent momentum could stall as VZ inches closer to the $42 level.
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Verizon ROE and ROIC by FY. Data source: Morningstar, S&P Cap IQ
As seen above, Verizon’s ROE and ROIC levels have fallen dramatically over the past 10 years. Over the same period, VZ’s 10Y total return CAGR of 2.16% has underperformed its index benchmark of 11.8% for its shareholders.
However, we know that past performance is not an indicator of future results. The market is forward looking, and we should consider how Verizon’s operating performance could be, moving ahead.
Verizon & T-Mobile forward ROE % consensus estimates (TIKR)
As seen above, Verizon’s ROE estimates are expected to continue falling through 2025, while T-Mobile’s projections are expected to increase further. As such, we believe it’s likely challenging for the market to reverse the underperformance of VZ against TMUS over the medium term, particularly if interest rates remain high.
Our WACC modeling suggests that VZ has a WACC of about 10%, while TMUS has a WACC of about 8.5%. However, VZ’s falling ROIC and ROE trend could instill more negative sentiments, suggesting excess returns could fall into the negative zone moving forward, eroding shareholder value.
Hence, while its dividend yield is significantly higher than its 10Y average, Verizon’s excess returns likely don’t justify the risks at the current levels.
As such, investors should demand a much wider margin of safety from the $42 level before assessing another buying opportunity.
We would consider at least a 30% implied upside to the $47 blended fair value estimate at the minimum, suggesting an entry level closer to $36. That level saw buyers returning strongly in December and mid March, suggesting buyers are confident about the margin of safety implied at that level.
Hence, we move to the sidelines from here as the margin of safety isn’t sufficient to justify VZ’s relatively weak ROE projections moving forward. Also, its price action doesn’t indicate an optimal entry zone.
Rating: Hold (Revised from Buy).
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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