2023-10-10 07:00:00 ET
Summary
- Verizon Communications Inc. management remains optimistic about the company's performance in the second quarter.
- The telecom industry is undergoing significant changes, requiring Verizon to adapt to maintain its advantage.
- Determining market share and profitability goals combined with technology changes will be crucial for investors to assess Verizon's dominance in the market.
- T-Mobile CEO remarked about the increasing competitiveness of the industry.
- The lead issue appears to be a minor and possibly insignificant future consideration.
Verizon Communications Inc. (VZ) has long been seen as a leader in the current telecom industry. Management gave a pretty upbeat second quarter report. But the continuing changes to the telecom industry require management to maintain some level of diligence to maintain that advantage. Too many of us have seen industry leaders get over-confident and disappear over time. Estimates go by that as many as one-quarter of the Dow stocks (for example) will be gone every 25 years (give or take). The telecom industry will likely change dramatically as technology continues to advance. Watching Verizon change with it will be a shareholder challenge to determine a continuing investment strategy.
Increasing Competitiveness
The T-Mobile US (TMUS) CEO recently warned that the mobile business is becoming more competitive. What will be part of the challenge for investors will be to determine proper market share and profitability goals to determine if Verizon maintains its relative dominance in the markets it is in.
There are currently three main competitors in this business. Depending upon how technology evolves, that could change. It could change a lot if the wireless business ever gets to the point where cables are no longer needed for the business. Right now, that is not the case as wireless handles limited amounts of data at one time. Cables handle data transmission that wireless cannot currently handle.
The Lead Issue
This is recently a big issue for shareholders and is something that needs to be put to rest quickly, as it is likely to affect the perception of the industry. This is the management answer given by Hans Vestberg, Chairman & CEO:
"When not disturbed, the likelihood of exposure to lead from lead sheath cables is low. In addition, because the lead sheath cable was used as a feeder and distribution cable and does not run into individual homes or apartments, it is generally in locations that minimize the potential for public contact. We are working with a third party expert to conduct our own testing at our sites that were identified by the media."
Source: Management Answer During Second Quarter Conference Call 2023.
This answer roughly corresponds to the answer given by AT&T Inc. (T) management:
AT&T Management Answer To Lead Paint Issue (AT&T Presentation Given At Bank Of America Securities Media, Communications, And Entertainment Conference September 2023)
AT&T management already had the results of tests at sites along with the results of tests taken by independent parties (like regulators and governments). Unless someone has been very negligent, there is enough evidence between the two answers to indicate that this will not likely be a big deal in the future.
Verizon management did mention that they needed to go through the records of some previous acquisitions. But that is not close to saying there is definitely an issue. The thing to remember here is the lead cables represent old technology that has been periodically replaced as needed (or indicated). This is not something that was used "yesterday."
As far as workers go, they would only deal with these cables in a repair situation or a replacement situation. Even then, it should be relatively easy to take the care needed to avoid a regulatory and unfavorable press coverage nightmare. In this day and age, most managements would see to it that the whole situation is properly handled.
Back To The Business- Cash Flow
On the same conference call, Tony Skiadas, Executive Vice President & CFO gave the latest guidance on the Free Cash flow.
"The net result of cashflow from operations and capital spending is free cashflow for the quarter of $5.6 billion. Free cashflow for the first half of the year is $8 billion, a nearly $800 million improvement from the previous year, driven by a combination lower CapEx spend compared to the prior year, and operating cashflow benefits previously mentioned. While we do not normally guideline free cash flow, our strong results give us a clear line of sight to more than $17 billion of free cash flow for the full year."
Source: Verizon Second Quarter 2023 Earnings Conference Call.
What is interesting about this is that the free cash flow is clearly mostly arriving in the second half. Also implied by the figures above was a weak cash flow in the first quarter.
Interestingly, competitor AT&T faced far more questioning of the cash flow because of a relatively weak first quarter followed by an improving second quarter with of course, more cash flow in the second half. I covered this in a previous article that the cash flow pattern was changing due to the recent series of divestments that left AT&T as a competitor to Verizon without all the other divisions.
When AT&T management guided to the light first half and a particularly weak first quarter, the market clearly did not buy it until cash flow somewhat improved in the second quarter. But the market is now demanding proof that will likely arrive with the third quarter reports throughout the industry.
This represents the market attitude in Verizon's case, of a continuing market pattern. The contrast is to the new cash flow pattern (which will now match the cash flow of the competitors) for AT&T after all the divestitures. Even though the new cash flow pattern will match the competition, the market does not buy it until a record is established.
Clearly, Verizon had no problem with roughly the same type of forecast. That is likely because Verizon never really went on an acquisition binge. So, there was no non-core division to play havoc on the results that would then result in a bunch of divestitures and a focus on the remaining business.
The other key is that Verizon clearly did not go overboard with debt and therefore has less debt to repay to get the debt structure to management accepted levels. The business has clearly benefitted as well.
Earnings
Earnings for the current quarter were actually down compared to the same quarter in the previous fiscal year. But year-to-date earnings, while down not as much, appeared to be in a normal range that would allow the company to recover the remaining deficit in the current fiscal year.
Verizon Consolidated Total Picture Earnings Second Quarter 2023 (Verizon Second Quarter 2023, Earnings Conference Call Slides)
If the trend shown above continues, then this is a company that will be growing overall in the lower single digits because the wireless industry appears to now be mature with slow growth ahead.
This is an industry that has changed tremendously from landline phones when I was a whole lot younger. Probably the next change is to wireless transmission of information that now requires fiber. How and when we get there is an unknown at this time.
To me, that means there is every chance that this industry will require a lot of innovation in the future to keep up with advancing technology. That is usually atypical of mature industries, but it is typical of the technology changes sweeping industries in general.
Key Business Measures
Management did note that the business appears quite healthy.
Verizon Key Operating Measures (Verizon Second Quarter 2023, Earnings Conference Call Slides)
Management clearly wants to improve those negative numbers going forward. They made that quite clear on the conference call. Therefore, I would look for an update on the upcoming earnings report.
Clearly, the overall growth is there. But growth is a lot easier to achieve if some of that underperformance gets taken care of.
Going Forward
This industry is likely changing from a growth industry to a growth and income industry. In the case of Verizon, the stock decline that is taking place may not lead to a full recovery because the business is well run and market expectations are changing for this business. Those market expectations are heading towards likely slower growth.
The Verizon Communications Inc. dividend has an above average yield which likely means that the stock is in bargain territory. But the current bearish market sentiment is likely to end at some point with a total capitulation that some investors may want to wait for. Others may consider the stock a buy now as a future growth and income vehicle. Investors may not catch the exact stock price bottom. But the stock does appear to be a bargain now, with the risk that it may get to be more of a bargain as the current bearish sentiment continues.
A likely future return in the low teens from a currently large dividend and low to high single digit growth is likely to be a reasonable expectation. To me, that means the stock was overpriced before. But the stock is no longer overpriced going forward as long as management keeps the company competitive position in the industry.
Management is guiding to very roughly a 3% revenue growth. That should be expected in current years unless a new product appears in the industry to change the industry prospects.
As a result, both Verizon and ATT are rationalizing operations. In plain English, that means cost-cutting and layoffs. The one good thing is that the industry does have a sizable capital requirement to enter the industry. That keeps competition to T-Mobile, Verizon, and AT&T. The smaller players as a rule do not affect overall competitiveness because they usually pay one of the three to use their systems.
For further details see:
Verizon: Will Management Get Overconfident?