Big Red Generating Big Green
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I've argued in the past, that both Verizon (NYSE: VZ) and AT&T (NYSE: T) benefit in their wireless subsidiaries because of their existing size. Call it the network effect or whatever you want, but more people tend to sign up with a wireless service that most of their friends and family are already using. With Verizon's recently reported earnings, you can clearly see that this positive network effect is helping the company grow their wireless division in particular. Since Verizon Wireless is the primary growth engine for the company, this is good news for investors.
The company announced that revenue increased 3.7%, and EPS increased 12.3% compared to last year. Not surprisingly, the company's primary growth came from their wireless division. In an interesting twist, the company's wireline performance was actually not that bad. Considering that many people have suggested that landline telephones are going the way of the dinosaur, this was a positive surprise for investors. The company also said that they are, “on track to produce solid double-digit earnings growth for the year.” Given this positive outlook, let's break down the earnings report and see exactly what's going on with this dominant telecom player.
Today - Wireless:
In the Wireless division, revenue was up 7.4%, and more impressively data revenue increased 18.5%. The company added 1.2 million retail net additions, and 888,000 of these were retail postpaid customers. This increase in total retail represented a 4.9% growth rate on a year-over-year basis. Verizon also saw average revenue per user up 3.7%, and churn at a low 0.84%. Given the popularity and number of choices of smartphones, not surprisingly the number of new sign-ups using these devices increased significantly from last year. In particular, 73% of new customers signed up to use a smart phone versus 59.5% last year. This would appear to be good news for investors, as smartphone users tend to be much more heavy data users than others. Since the company is seeing higher data usage growth, the more smartphones that are added to the system, the better future growth should be.
The Past - Wireline:
In the Wireline division, the company saw operating revenue down 3.1%; however, consumer revenues actually increased 2.5%. The company's FiOS service is helping to drive the results in this division. Specifically, 65% of consumer revenues were generated by FiOS. This trend contributed to average revenue per user now at above $100, and helped drive both Internet and video net additions. During the quarter, Verizon added 134,000 FiOS Internet additions, with a total count of 5.1 million customers. The company also added 120,000 FiOS video net additions, with a current count of 4.5 million. There is still opportunity for the company to grow both measures, as Verizon only has 36.6% penetration for Internet, and 32.6% penetration for video.
The Future - Global Enterprise:
In the company's Global Enterprise division, revenue was down 3.4%; however, sales of strategic services like Terremark cloud services, security, and IT were up 4.4%. In the future, the company hopes that Global Enterprise will contribute a greater portion of the overall growth the company expects. Over time, large companies will turn to experienced telecom and hardware providers to outsource their cloud computing needs. While Verizon is a relatively small player, there's no question the company has the assets and the experience to compete effectively in this field.
Cash Flow Machine:
When it comes to Verizon's financial statements, the numbers are truly impressive. Long-term debt has been cut by $3.8 billion in just the last six months. In addition, the company's free cash flow of $7.8 billion was up 102.4% versus last year. This huge free cash flow meant the company's payout ratio was just 32.99% in the current quarter. Clearly Verizon is doing a lot of things right, and this would seem to spell trouble for their competition.
Verizon basically has two major competitors in AT&T and Sprint (NYSE: S). While the company has to be aware of smaller competitive players, these two companies represent the main challengers. AT&T and Verizon have been battling for market share in their wireless divisions for multiple years. Both companies are expected to benefit from the increased amount of data usage on their respective networks over the next few years. You can see this trend by the fact that analysts have increased their growth expectations for both companies, from 5% to 6% just a few years ago, to 9.57% for AT&T, and 10.64% for Verizon. In addition, both companies are well known for their dividend yield. With Verizon's current yield at about 4.5%, and AT&T yielding just over 5%, these two stocks have been favorites of income oriented investors for years. As proof that both companies operate very similarly, consider that in their most recent quarters each company's gross margin was over 59%.
The odd man out when it comes to the big three's competition is Sprint. The company has been struggling in multiple areas for the last few years. Sprint suffers from the fact that they have about half the total subscribers of either Verizon or AT&T. Secondly, the company does not pay a dividend, and long-term debt has been a concern for investors. With both Verizon and AT&T expected to see good growth rates in the next few years, it's telling that analysts expect just 5% growth from Sprint. In addition, to compete more effectively sprint is unable to charge the same type of rates that its larger two competitors do. Through its cheaper pricing plans, and still unlimited data options, Sprint hopes to differentiate itself to heavy data users. The problem this causes is the company has to accept a lower gross margin from its sales. The company's gross margin specifically was 41.78% last quarter versus over 59% at its two larger competitors.
At this point, investors should feel confident selecting either Verizon or AT&T if they are looking for both growth and income. However, Verizon has been growing wireless subscribers faster, and the company is expected to see larger earnings growth in the future. Since investors don't give up much dividend yield for these 2 positive traits, you can see why big red could mean big green for investors.
MHenage owns shares of Verizon Communications. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.