TBC - Verizon: Q1 2023 Weakness Calls For Further Turbulence Ahead

2023-04-25 08:45:55 ET

Summary

• Verizon Communications Inc. reported mixed first quarter results on Tuesday morning, with post-paid phone subscription net losses and deceleration in FWA subscription adds.
• Yet, management has reiterated its guidance for 2.5%-4.5% revenue growth, with up to $48.5 billion in adjusted EBITDA this year.
• This leaves Verizon with much to do for the remainder of the year, which bodes unfavorably with the worsening economic backdrop, escalating execution risks ahead.

Despite an attractive dividend yield of almost 7%, and engagement in a largely mission critical business amid looming recession risks, the Verizon Communications Inc. ( VZ ) stock continues to struggle in finding momentum for a sustained recovery. The stock remains in the red this year, underperforming the broader market, and mixed first quarter results are doing little to drive a much-needed sentiment lift.

Specifically, Verizon’s net post-paid mobile subscription losses during the first quarter continue to trail resilience exhibited by peers by wide margins, underscoring elevated execution risks still when it comes to plans for recouping 5G investments and stemming market share loss to competition. Meanwhile, the ongoing roll-out of its fixed wireless access (“FWA”) broadband also appears to be losing steam, with a stark q/q slowdown in the pace of subscription adds from 37,000 during the fourth quarter to a mere 14,000 during the first quarter ahead of weakening consumption in the U.S.

Although the stock now trades much more in line with peers relative to its fundamental performance, growing signs of structural deceleration in Verizon’s already slow-growing telecom business is expected to weigh on its underlying valuation prospects further. And despite an industry-leading dividend yield at current levels – which is enticing to its income-focused investor base, especially ahead of an uncertain market climate – the lack of confidence in the durability of Verizon’s financial performance and, inadvertently, its cash flows and valuation outlook will likely keep markets on the sidelines for longer.

VZ Q1 2023 Earnings Overview

Verizon reported revenue declines of 1.9% y/y to $32.9 billion for the first quarter, missing consensus estimates and indicating a worsening drag from weakening subscription volumes on relatively resilient ARPU. Specifically, post-paid phone subscriptions came in at a net loss of 127,000, with the drag coming primarily from the consumer segment at net losses of 351,000. Although management has attributed much of the downtrend to ongoing changes in its go-to-market strategy, as well as the wind-down of its SafeLink brand, the results continue to underscore the burden of looming macroeconomic challenges.

In the short term, these actions are having a negative impact on prepaid net additions. The reported result was also due to elevated disconnects in the SafeLink brand.

Source: Verizon 1Q23 Earnings Press Release .

This accordingly puts Verizon’s previous guidance for 2.5% to 4.5% growth in the current year at higher risk, with the first quarter – despite seasonality weakness – off to a slower start than the prior year.

Meanwhile, earnings were in line with consensus estimates at $1.20 per share. The results continue to corroborate the critical role that Verizon’s higher-margin FWA business has on its bottom line. However, stark deceleration in FWA subscription growth during the first quarter, as noted in the earlier section, elevates execution risks ahead at the telecom giant as macroeconomic challenges are expected to persist through the remainder of the year.

Growing Signs of Structural Deceleration

On the mobile front – a core focus area as Verizon steps off its yearslong 5G investment cycle towards ramping up returns – postpaid subscriptions continue to trail those of peers by a long way. The company lost 127,000 postpaid phone subscriptions on a net basis during the first quarter, declining from 217,000 net adds in the prior quarter and trailing significantly behind rival AT&T Inc.'s ( T ) 424,000 added over the same period. While management has reiterated their focus on ensuring service revenue growth over subscription volume expansion, stark deceleration in the former metric underscores weakening ARPU resilience, and an overall lack of balance in the strategy. This, accordingly, puts its free cash flow guide for the year at risk, dialing up investors’ angst especially ahead of rapid deterioration in consumer spending.

Despite Verizon’s mission critical role in the provision of connectivity services, its business is not immune from looming macroeconomic uncertainties. As discussed in a previous analysis , recent economic data is painting an increasingly bleak picture for the consumer, which had stayed largely resilient over the past year of persistent inflationary pressures and aggressive interest rate hikes. With retail sales on a consistent decline this year, alongside “ emerging cracks ” in the labor market that will compound persistently high inflation by challenging wage income and household savings, Verizon likely faces a worsening demand environment ahead. Specifically, consumers are becoming increasingly cautious on spending, which is corroborated by the dip in both debit and credit card reliance in March.

Although the mission critical role of Verizon’s wireless mobility services, alongside the long-term contracted nature of most post-paid subscription plans will help to stem churn – which is consistent with its retail post-paid phone churn rate that has been sitting comfortably at a record low of < 1% – new customer acquisition will likely become increasingly difficult over the near-term and potentially at a higher cost. In line with seasonality trends, growth during the second quarter of the year is typically subdued, considering the lack of back-to-school and holiday demands, new device roll-outs, and commercial contract renewals. Paired with aggressive price competition among a dense group of peers, especially as consumer spending behavior stays conservative amid a challenging macro backdrop, Verizon may need to pull on the promotion lever yet again to maintain its market share. Specifically, given consistently improving reliability and performance in wireless mobility services available today, supported by an expansive network coverage across the U.S., price remains the primary consideration among consumers when choosing their plans. As such, rising competition alongside the macro-driven increase in price sensitivity risks a continuation of promotion cost headwinds in the near-term at Verizon, which have already been consistently weighing on its wireless service revenues in recent quarters.

Amortization of handset promotion costs continues to increase and is a headwind to wireless service revenue…

Source: Verizon 4Q22 Earnings Press Release .

This again highlights the challenges in ensuring an adequate balance on prioritizing services revenues without neglecting the need to maintain subscription volumes – something we view management is failing to do, which could weaken margins as macroeconomic conditions deteriorate further over coming months.

Meanwhile, on the FWA front – which is a key component of Verizon’s longer-term growth and profitability strategy – momentum appears to be fading. Recall that FWA is a higher-margin business, given it leverages the same 5G infrastructure as wireless mobility, and is key to scaling returns on Verizon’s capital-intensive investment cycle over the past several years. Yet, with net FWA subscription adds decelerating at a rapid pace from +37,000 during the fourth quarter to +14,000 during the first quarter, momentum in the key growth strategy is likely losing ground to rising competition alongside stiff macro headwinds.

Specifically, deceleration in Verizon’s FWA net adds observed during the first quarter indicates potential challenges from unfavorable housing data in recent months. U.S. home prices remain on the rise, increasing by 4.7% y/y and 1.0% q/q during the first quarter, while rising borrowing costs continue to push average 30-year mortgage fixed rates near record high levels of almost 7% . With affordability still a challenge, the ensuing pressure on new home sales will likely stem FWA demand by slowing upgrades from legacy broadband. This will accordingly drive an increasing challenge to management’s goal of shoring up service revenue growth and free cash flows in the near-term, especially as the higher-margin FWA segment’s mix potentially decelerates further ahead of looming macro uncertainties.

Implications for Verizon

Admittedly, Verizon’s near-7% dividend yield remains a primary attraction for the stock, especially as management commits to raising pay-outs further:

Our current streak of raising the dividend 16 years in a row is unmatched in the industry, and we intend to be able to continue that trend.

Source: Verizon 4Q22 Earnings Call Transcript .

However, stalling wireless mobility and FWA subscriptions ahead due to transient macro headwinds and stiffening competition, alongside growing signs that the ailing trend is becoming entrenched, risk severing a critical link to ensuring durable market share gains and capital efficiency needed to sustain future cash flow growth at Verizon. This is especially difficult to stomach as Verizon looks to recoup capital-intensive 5G investments deployed over past years within the already slow-growing telco industry.

Admittedly, Verizon Communications Inc.’s income-focused investor base likely cares little for outsized growth. But without confidence that cash flows can expand sustainably alongside valuation prospects that can be backed by durable fundamentals, Verizon Communications Inc.’s high dividend yield may be implying further underlying weakness rather than a value opportunity, drawing caution ahead.

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