Verizon: an undervalued telecom – GuruFocus.com

Verizon (VZ, Financial) is one of the largest telecommunications providers in the world and the largest wireless carrier in the United States. The company is poised to benefit from a lot of tailwinds from the 5G industry, but partly due to the capital-intensive nature of the business and the way it operates, analysts don’t tend to be optimistic about this. topic. Still, Oppenheimer Research upgraded the stock to “outperform” after two years of negative ratings as Verizon signed a massive $1.58 billion contract to upgrade US embassies in a landmark deal.

Core business

Verizon has over 90 million phone customers across its three primary segments; Consumer, business and government. Verizon also has legacy landline service in the northeastern United States, which generates about 12% of revenue.

5G Tailwinds

The 5G industry was worth $64.5 billion in 2021 and is expected to grow at a meteoric compound annual growth rate (CAGR) of over 44% between 2022 and 2030 according to estimates from Precedence Research. At the end of this period, the industry is expected to be worth $1.87 trillion. Verizon’s prominent position in the market means the company is poised to become the backbone of the 5G industry in the United States

Verizon also announced its “Network as a Service” strategy, which outlines bold plans for the 5G network. As part of this new strategy, Verizon has acquired 5G midrange spectrum and aims to bring 5G to more than 50 million homes by 2025. The speed of 5G means it could eventually disrupt broadband home and create a true wireless experience, whether at home, at work or on the go.

In September, Verizon even won an $11.5 million contract from the US Department of Defense to build a private, secure 5G network for an aircraft hangar at Joint Base Pearl Harbor Hickam (JBPHH). This network will be used for various maintenance-based experiments and could open the door to larger defense contracts in the future.

Verizon is also working on multipoint computing with partners such as Cisco (CSCO, Financial). This advanced technology aims to bring the power of the data center closer to your device. As a simple example, let’s say a company has created an AI-powered app that uses your mobile camera for image recognition. An application like this would need access to a large database and would need the ability to run machine learning or AI algorithms on the images, usually in a data center. That’s fine, but often the data center isn’t close and so latency in the application would be built in. However, with MEC, that latency will be removed, opening up a whole host of possibilities from 3D video streaming to the Metaverse.

More recently, Verizon secured a $1.58 billion order to retrofit US embassies with new IT services under a lucrative 10-year deal. The gradual stabilization of the company’s subscriber base also caused Oppenheimer Research to upgrade the stock to “outperform” after two years of negative ratings.

M&A activity

In 2015, Verizon went on a shopping spree and acquired internet giant AOL for $4.4 billion. The company also acquired Yahoo for $4.5 billion in 2017. These used to make up Verizon’s Media brand, but in 2021 the company sold those assets to private equity firm Apollo Global Management (APO, Financial) for a paltry $5 billion, less than half of what Verizon originally acquired them for. Despite the poor acquisition history, Verizon continually reinvents itself and so it’s probably for the best that the company has been selling off unrelated units.

finance

Verizon reported strong financial results for the second quarter of 2022. Revenue was $33.8 billion, beating analyst estimates of $11.57 million. This was driven by higher-than-expected wireless equipment revenue, offset primarily by declines in wireline services. Wireless service revenue jumped 9.1% year over year. This was due to the acquisition of TracFone in the fourth quarter of 2021. However, services revenue decreased by 3.9%, due to losses related to the sale of Verizon Media.

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The company generated net income of $5.3 billion in the second quarter, down 10.7% year-over-year. This was again driven by the sale of Verizon Media and aggressive marketing investments for its wireless service. Therefore, I don’t consider it to be a major long-term problem.

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Cash flow from operations was a staggering $17.7 billion in the first half of 2022, down slightly from the $20.4 billion generated in the first half of 2021. However, this was primarily due to higher inventory high and lower working capital, which is not a major issue as inventory can be worked.

Verizon’s balance sheet consists of $1.98 billion in cash and short-term investments. Additionally, the company has a monstrous amount of unsecured debt with $130.6 billion reported. The good news is that management paid off this debt balance and reduced it by $5 billion in the second quarter.

Healthy dividend

Verizon pays a healthy forward dividend yield of 6.62%, which has grown at a rate of 2% per year for the past five years. Additionally, this dividend has grown steadily over the past 18 years, making it a solid option for dividend reliability.

Evaluation

In order to value Verizon, I incorporated the latest financial data into my advanced valuation model, which uses the discounted cash flow valuation method. I’ve projected conservative revenue growth of 5% for next year, then 6% per year for the next two to five years.

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I also forecast the company to slightly increase its operating margin to 20% over the next eight years, which is also conservative in my view.

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Considering these factors, I arrive at a fair value estimate of $53 per share. The stock is trading at ~$40 per share at the time of writing and thus offers a significant margin of safety of around 30%.

Verizon is trading at a price-to-earnings ratio of 7.6, 32% cheaper than its five-year average.

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Final Thoughts

Verizon is a traditional telecommunications company that still has growth potential through technological advancements, even though it primarily operates in a closed and saturated market. The company has high debt, but it has managed debt well historically and it appears undervalued relative to historical multiples at the time of writing.

About Jimmie T.

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