buy and sell

Don't Be Foolish On Verizon Communications (VZ)

Verizon Communications (VZ) failed to end 2014 on a positive note. Despite making noteworthy gains throughout 2014, investors kept selling the stock in the final trading days of the year. The share price of Verizon declined about 6% just in December as investors were worried about the company’s Q4 margins in the wake of growing price competition and aggressive promotions by rival Sprint. The No. 3 wireless carrier introduced last month a “Cut Your Wireless Bill in Half” promotion, giving customers of Verizon and AT&T an opportunity to cut their bills in half as they switch to Sprint. To make it work better, Sprint will also help them pay early termination fees and activation fees.

The recent tactics employed by Sprint pushed Verizon to announce its own promotions in the fourth quarter to avoid losing customers, which means Verizon’s margins will suffer this quarter and growth in metrics (considered important in the telecom industry) like average-revenue-per-account (or ARPA) is losing its pace somewhat.  Let’s take an example, Verizon’s ARPA saw an increase of just 3.5% last quarter, year-over-year, which was down as compared to the historical rate of around 5%. Sprint brought in its limited-time half-off deal on Dec. 5. Verizon management warned investors that fourth-quarter wireless margins will be hurt and there will be higher than normal customer churn.

Verizon management warned investors to expect slightly lower wireless margins and higher-than-normal churn. However, Verizon is optimistic about reaching back to historical levels in the first quarter of 2015. Verizon’s margin compression seems to be short term hiccups, as such promotions were unlikely to continue in the long run.

Verizon stick to its mission

It is important to keep in mind that even if margins decline slightly for one quarter, Verizon continues to lead the wireless industry with the highest margins. For that reason, Verizon’s wireless EBITDA margin was at 49.5% last quarter when AT&T had reported a 43%. Verizon maintains a disciplined market approach focused on high-quality customers, not necessarily the most customers, because so-called high-quality customers are attracted toward high-quality 4G and 4G LTE services, which come along with higher margins. Verizon declared on Jan. 6 that wireless margins are expected to become normal next quarter. Verizon had reported strong customer service upgrades, which are driven by new product launches. That opposes the view that Sprint’s price war strategy will deal its rival a serious blow.

Is It Time to Buy?

Looking at the company’s valuation to find out if it offers buying opportunity, Verizon looks attractive as the share price is currently sitting at about nine times trailing earnings and 12 times forward earnings estimates. These multiples are attrative when compared to both the overall market and Verizon’s strong rival, AT&T, which is available at 10 times trailing and 13 times forward earnings-per-share estimates. Moreover, Verizon’s valuation multiples are near their 5-year lows, which suggest investors are not giving much credit to the company’s efforts to make things right. Now, one should not disregard Verizon’s strong 4.8% dividend yield, which keeps paying well in tough times.

Conclusion

While Sprint’s deadly moves will hurt Verizon’s wireless margin in the fourth quarter, as Verizon has responded by offering margin-eroding promotions to retain customers, this may not be a long-term problem. In addition, Verizon keeps offering high-quality customer upgrades to 4G that helped it report strong momentum for customer growth and adoption in December. Another point to note is that Verizon still expects margin expansion this year in its wireline business, which accounts for about one-third of its total revenue, thanks to continual uptick in FiOS service adoption. All these bullish views should keep Verizon’s long-term earnings growth intact. This is why the sensible approach for investors is not to sell Verizon right now.

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