Monday, August 08, 2011

Verizon Stock Looks Good on Artificially Depressed Share Price

Verizon Communications (NYSE: VZ) is suffering as a strike by 45,000 of its landline phone workers goes into its second day. But odds are good that the strike won't cost much over the long-term. But should you buy the stock or are the competitive pressures that Verizon management cites for asking workers to accept cuts a reason to stay away from Verizon shares? 

The last time Verizon workers went on strike was 11 years ago. Back then, the 18-day standoff affected 28 million customers and cost Verizon $40 million in revenue -- ultimately settling the strike with an agreement to boost wages 12% over three years, according to Bloomberg.

Now, thanks to declining landline revenues due to competition from Comcast (NYSE: CMCSA) and others, Verizon management is asking workers to pay for some of their health care premiums. But even if Verizon management succeeds in its efforts to cut worker benefits, it remains to be seen whether it will stop the loss of market share in the landline business.

So should you buy Verizon stock or avoid it? Here are three reasons to consider buying:
  • Reasonable valuation. Verizon's price to earnings to growth of 0.96 (where a PEG of 1.0 is considered fairly priced) means it is reasonably valued. It currently has a P/E of 15.7 and is expected to grow 16.3% to $2.61 in 2012.
  • Attractive dividend. Verizon has a 5.56% dividend yield -- a very strong reason to buy the stock.
  • Many expectations-beating earnings reports. Verizon has beaten analysts’ expectations in four of the last five reporting periods. In its 2011 second quarter, Verizon reported $0.57 in adjusted EPS -- two cents above analysts' expectations. It benefited from wireless subscriber growth coming from Apple (NASDAQ: APPL) iPhones and Google (NASDAQ: GOOG) Android phones.
  • Out-earning its cost of capital. Verizon is earning more than its cost of capital – and it’s improving dramatically. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first six months of 2011,Verizon EVA momentum was a 7%, based on first six months' 2010 annualized revenue of $107.4 billion, and EVA that rose from negative $6 billion annualizing the first six months of 2010 to $2 billion annualizing the first six months of 2011, using a 7% weighted average cost of capital.
One reason to avoid this stock is its rising sales with declining profits and a weaker balance sheet. Verizon has been growing with declining margins. Its $106.6 billion in revenues have grown at an average rate of 4.9% over the last five years while its net income of $2.6 billion has tumbled at a 17% annual rate over that period -- yielding a slim 2% net profit margin. Its debt has grown twice as fast as its cash. Specifically its debt has grown at a 12% annual rate from $28.7 billion (2006) to $45.3 billion (2010) while its cash has grown at a 6% annual rate from $5.7 billion (2006) to $7.2 billion (2010).

Verizon pays a high dividend, is accelerating growth thanks to wireless demand, is earning more than its cost of capital, and usually beats quarterly earnings expectations. If these trends continue, the stock should benefit.


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