Which Major Domestic Telecom Should Investors Prefer?

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After the latest round of earnings releases, it’s important to assess the performance of industry leaders. In a sector such as telecommunications, which is dominated by two major players, investors have quarterly reports to digest that show two companies moving in two different directions.

On the day of their respective earnings announcements, Verizon (NYSE: VZ) rallied while AT&T (NYSE: T) declined sharply. Investors of either company, or those individuals considering the nation's biggest telecom stocks, would be wise to consider the underlying reasons.

A tale of two telecoms

Verizon’s report contained a basket of positive notes. First, the company’s first-quarter consolidated earnings per share rose 15% year over year.

In particular, the success of Verizon’s Wireless segment continues to impress the market and is the major contributing factor behind the stock’s 32% rally over the 52 weeks ended April 23. First-quarter results from the company’s bread-and-butter segment kept the trend going. Verizon realized 8% year-over-year increases in both service revenues and retail service revenues, and achieved record operating and earnings before interest, taxes, depreciation, and amortization (EBITDA) margins.

AT&T, meanwhile, fell more than 5% on the day of its own quarterly report. Despite seemingly solid results, the stock dropped hard anyway. AT&T posted 12% higher diluted earnings per share year over year, and nearly $4 billion in free cash flow.

What lies beneath

At first glance, investors might view the two stocks as equals. After all, they’re each large-caps, with market values each in excess of $140 billion. In addition, they offer identical business models and similar dividend growth over the past several years.

However, if you dig deeper into their perspective reports, you can see where the divergences. AT&T’s operating and EBITDA wireless margins are several percentage points lower than Verizon’s. In addition, Verizon grew sales during the quarter while AT&T did not. Verizon posted 4% growth in consolidated revenue, versus AT&T’s 1.5% consolidated revenue decline during the quarter.

AT&T has a revenue problem

Going back further, we can see that the trend of Verizon outperforming AT&T on operating revenue growth is not contained to just one quarter. Verizon’s fiscal 2012 results showed revenue growth of 4.5% versus AT&T’s flat revenue year over year.

What’s more, the fiscal 2012 revenue results for each company are indicative of their longer-term trajectories. Since 2008, Verizon has posted compound annual revenue growth of 4.5%. Meanwhile, AT&T has grown its revenues by less than one percent compounded annually over the same period.

The stark differences in sales that each company is experiencing likely stems from the respective performance of each company’s wireless segments. AT&T posted a net increase in total wireless subscribers of 291,000 in the first quarter, which sounds impressive, until you consider that tablet devices reflect 365,000 additions during the quarter. Therefore, it appears the number of phone customers is actually down.

Verizon, on the other hand, dialed up 677,000 retail wireless net additions during the first three months of the year.

A clear choice

Income investors might be tempted by AT&T’s higher dividend yield, which stands at nearly 5% after the stock’s poor price performance post-earnings. However, Verizon’s lower dividend yield, approximately 4%, is a result of the company’s soaring stock price and not because of lower dividend growth.

AT&T has increased its dividend for 29 years in a row, but the company will have a tough time raising its dividend to a satisfactory degree going forward if it doesn’t get revenue back on track. On the other hand, Verizon is providing investors solid revenue growth that should propel both capital gains and dividend increases in the future. Because of Verizon's vast revenue outperformance, investors should prefer Verizon.

Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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