Why? That’s always the first question to ask when you see a common stock like Verizon (VZ) trading with a dividend yield of 6.52%. That’s so much higher than the yield on the Standard & Poor’s 500 (2.3% as of the end of the September) that any reasonable investor wants to know what the market thinks is wrong with this company?
In this case I think it’s easy to figure out why enough investors hate this stock to drive the yield up so far.
And to conclude that the market is wrong in the degree of its worry. Which makes Verizon a buy for the investor in search of reasonably safe but high yields.
Here’s what’s wrong with Verizon: Â
The company’s landline business is slowly shrinking. In the second quarter phone lines to homes and businesses declined by almost 10% from the second quarter of 2008.
The U.S. wireless market, which is supposed to grow fast enough to make up for the drop in land line phones, is nearing saturation. There are now nine mobile devices in circulation for every 10 people in the United States.
Verizon’s solution is to invest in its network so that it can add more very profitable Internet and video users through its FIOS system. That’s enormously expensive. The company plans to spend $23 billion in 2009 and 2010 to build out its fiber optic network.
Verizon already carries a huge amount of long-term debt. The company finished the second quarter of 2009 with $59 billion in debt.
That’s a sizeable list of worries and most of them are reasonable. Which is why the price is low enough for the stock to pay a 6.52% yield.
But while these worries are reasonable, they are overblown. (For more on Verizon’s business see my August 14 post https://jubakpicks.com/2009/08/14/verizon-vs-att-the-winner-is-the-bravest-cannibal / )
Yes, Verizon is losing landline customers. (Hey, it is a recession, remember.) But the company is losing them in a controlled fashion and its strategy of replacing the revenue from departing customers by getting remaining customers to upgrade to higher margin data, high speed Internet, and video services is working.
The crucial metric here is cash flow. The company’s cash flow from operating was a huge $23.6 billion in 2008. That was more than enough to cover the $1.90 per share annual dividend and the company’s capital spending.
The company’s board of directors signaled its confidence that this cash flow would continue by raising the dividend payout in the third quarter of 2009.
Yes, the wireless market in the United States is reaching saturation in numbers but there’s still room to take market share from Sprint Nextel (S), a fading #2, and to upgrade customers to new smart phones. Smart phone customers should be more profitable than regular cell phone users. Here the number to watch is AMPU or average margin per user. (Hats off to Morningstar for this insight and number crunching.) This ratio divides a company’s earnings before interest, taxes, depreciation and amortization (EBITDA) by the number of customers to figure out how profitable the average customer is. For Verizon the AMPU in the second quarter came out to a very healthy $24. That’s the highest in the industry.
Yes, Verizon’s build out of is fiber optic network is very expensive but as an investment it seems to be worth it on the numbers to date. In the second quarter Verizon added 303,000 net FIOS Internet customers and 300,000 FIOS Television customers.  On average FIOS customers pay a monthly bill of $135, about twice the bill for the average Verizon customer.
And yes, Verizon carries a huge debt load but the company has the cash flow and earnings to pay the tab.
In conclusion, I think the worries are over stated, the price is overly depressed, and the yield is a bargain.
Today, I’m adding Verizon to my Dividend Income portfolio to replace US Bancorp (USB) in that ten stock portfolio. I’ll start tracking the whole portfolio next week. Look for a new portfolio tab at the top of the page.
Full disclosure: I don’t own or control shares of any company mentioned in this post.
Jim, with todays downgrade regarding the ability for Verizon to pay it’s dividend is it time to sell?
hi Jubak, i wish you would talk more about how telco 2.0 will affect verizon and at&T. imo it is a real problem and could be detrimental to telcos as a dividend stock. see >> http://www.telco2.net/manifesto/
I prefer VOD over VZ. VOD has upside from its investment in VZ + a bunch of other advantages. I have a post on http://maxkapital.blogspot.com/2009/09/vodafone.html which might be of interest.
NEGATIVE: There’s been only one thing holding me back on buying into Verizon and that is the size of their unfunded pension obligations vs. pension assets. According to ValueLine, VZ’s is over $27 billion vs. T’s of only $4 billion. In its favor, VZ’s Total debt, Due in 5 yrs, and LT debt are all lower than T’s, with the LT Interest only half what T must pay. So, it is not just the fiber build-out and dividends they will need to cover in the future. Anybody care to comment on this?
POSITIVE: VZ’s Dividend Reinvestment Plan has no fees on additional cash and automatic investments, while T charges fees for both. VZ also allows buying into the plan directly for a minimum of only $250 and no set-up fee – very “shareowner friendly”- while T requires $500 + $10 set-up. These are important considerations if you are going to be adding to your investment over a long period as I plan to do.
I’m with you on this one Jim. For the first time I give VZ the nod over T on value and strategic position. T is getting a very bad reputation for service quality from their highest margin customers using the IPhone. Loss of exclusivity is inevitable and VZ is going to be the biggest beneficiary when those customers can finally get away from T. At the current quote an investor can clip a great dividend and reap at least a 10% capital gain in the next six months. From there it is a trickier situation but unless interest rates go up quite a lot VZ will not be the worst performer in a portfolio. The market is offering up a bargain right now so grab it!
Put VZ and the telco’s in context. They’ve been “victims” of serial perfect storms (many self-inflicted of course). But you’ve got the first stages. 1)Landline demise to 2)wireless transition. In both cases the future is a bandwidth war driven by bit-hungry apps. FIOS is the response on landlines while smartphones to drive content & apps on wireless. Fat pipe to premise competition is the driver of the first and the cable companies are in worse trouble. ATT is not badly positioned by only VZ is positioning for the strategic future – execution and being right are key questions. On the wirless side the theory is more content drives higher charges but requires more bandwidth – right now though the charges are too high to support an explosion of demand (a friend just had a $250K bill at list rates!). Beyond those there’s an even bigger picture strategic challenge is what does telcom look like int’l – Seindenberg lays the entire vision out on a Charlie Rose interview and how VZ is positioning. Worth a listen.
See also: “Ahead of the Curve, 9/17/09 @ Briefing.com for a brief history of the Verizon dividend and another positive perspective on VZ.