We are upgrading our recommendation on Verizon Communications (VZ), the second largest U.S. phone company, to Neutral from Underperform. The improvement is based on solid third quarter results as well as strong future growth prospects for the company.
Verizon reported stronger-than-expected earnings in the third quarter and surpassed the Zacks Consensus Estimate. Continued strength in Wireless, FiOs and strategic business services fuelled the earnings growth. Total revenue also improved driven by strong wireless revenues. However, wireline revenue remained under pressure due to persistent erosion of access line.
During the first nine months of 2010, Verizon’s cash and cash equivalents increased to $5.4 billion from $1.2 billion in the year-ago period. Debt-to-equity ratio declined to 58.4% from 59.3% in the year-ago period.
We believe Verizon’s continuous investment in its broadband network, strong wireless and FiOS services, share gain in the retail post-paid market and increasing smartphone penetration and other data devices will make the stock attractive for the long term. Further, the launch of fourth-generation (4G) long-term evolution network in 38 markets by the end of 2010 and the expected sale of Apple Inc.‘s (AAPL) iPhone starting in January 2011 will boost the company’s growth prospects. In terms of 4G network deployment, Verizon is way ahead of its bigger rival AT&T Inc. (T), which is expected to roll out its 4G services in mid-2011.
Further, Verizon remains committed to offer incremental returns to its shareholders via dividends and by leveraging a healthy free cash flow. Higher dividend indicates the strength of Verizon’s abundant free cash flow and rich balance sheet. The company recently raised its quarterly dividend by 2.6% to 48.75 cents per share, equating to $1.95 on an annualized basis. Currently, Verizon’s yield of 6.02% is higher AT&T’s yield of 5.89%. Verizon also pays a higher dividend than its rival Qwest Communication’s (Q).
On the flip side, Verizon poses some risks, which may pressure top and bottom line. We believe persistent erosion in access lines continues to hurt wireline revenues and margins as Verizon faces intense competition from cable companies and other alternative services providers. High promotional and restructuring expenses may drag earnings and margins going forward.
Although Verizon continues to expand its 3G wireless and wireline FiOS network footprint, returns from investments in these businesses are highly uncertain. Moreover, the 4G infrastructure may be an obstacle if other service providers shift to different generation technologies.
VERIZON COMM (VZ): Free Stock Analysis Report
Zacks Investment Research
