Bruce Bennett
High-yielding Telcos like Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (T) make compelling value propositions right now for passive income investors that want to lock in a low cost basis.
Verizon Communications has seen some new stock price weakness in December, as did AT&T, and both Telcos offer passive income investors robust underlying growth in their broadband operations, a low earnings multiple and raised forecasts as far as their free cash flows are concerned.
Verizon bumped up its free cash flow forecast for 2023 in the third quarter, and the Telco’s stock is selling for a mere 8.1x earnings multiple. Taking into account that Verizon Communications’ free cash flow forecast was raised, the Telco’s dividend margin of safety has improved also.
I consider VZ stock to be a steal at the present price level and upgrade my rating to a STRONG BUY stock classification.
My Rating History
I dissected Verizon Communications at the end of September and pointed to a contrarian entry opportunity. My Buy classification hinged on Verizon Communications’ broadband growth, robust postpaid performance in business and $17 billion in free cash flow. These drivers still underpin my Buy thesis for the Telco.
Though VZ has since appreciated 16%, the price increase is not deterring me from doubling down on the Telco as the stock has seen new weakness lately.
Furthermore, Verizon Communications continued to add a boatload of new customers in its broadband segment in the last quarter and raised its forecast for free cash flow by $1.0 billion, leading us to a higher margin of dividend safety.
The stronger free cash flow is ultimately why passive income investors want to consider Verizon Communications for their portfolios.
Solid Underlying Broadband Operations
Telcos don’t have a reputation for high sales and profit growth (though for high free cash flows that are available for distribution), but they do produce not insignificant growth with their broadband plans.
Verizon Communications’ broadband customer trend is in a profound upswing and the Telco added another 434K customers on a net basis in the third quarter. Thus, 3Q-23 was the fourth consecutive quarter in which the Telco added more than 400K broadband subscribers (also on a net basis).
Verizon Communications’ customer base is growing and the Telco finished the third quarter with 10.3 million customers in its broadband business, reflecting robust demand for the Telco’s Fios and fixed wireless products.
3Q-23 Operating Metrics (Verizon Communications)
Three Reasons To Own Verizon: Free Cash Flow, Improved Dividend Margin Of Safety, Yield
Up until the second quarter, Verizon Communications expected approximately $17 billion in free cash flow for 2023. The Telco upgraded its forecast for its 2023 free cash flow and now anticipates over $18 billion of free cash flow, reflecting a QoQ raise of $1 billion, primarily because of strong execution in the company’s just-discussed broadband segment.
The bump in the free cash flow guidance in itself was a nice surprise at the time, but it also had a comforting effect for passive income investors that have been worried about the Telco’s dividend sustainability.
Just like AT&T, which bumped its free cash flow forecast up by $0.5 billion, Verizon Communications has now better dividend coverage than before and thus a better-protected dividend that should last all throughout 2024.
Verizon Communications’ leading dividend coverage ratio is 161% (based on $18 billion in free cash flow) compared to 152% before (based on $17 billion in estimated free cash flow).
In a nutshell, Verizon Communications’ dividend is safer now than it was just 3 months ago, thanks to better-than-expected free cash flow. AT&T’s estimated dividend coverage ratio for 2023 is 206%, so AT&T’s dividend also has a rather high degree of dividend safety.
Ultimately, Verizon Communications’ free cash flow is the number one reason why passive income investors would want to own Verizon stock. The Telco has 4.2 billion shares outstanding and with $18 billion in free cash flow estimated for 2023, owners of Verizon Communications are set to earn $4.28 per share in free cash just this year. It stands to reason that the Telco will pay about the same level of free cash flow in the coming year as it derives its income and free cash from a growing portfolio of customers in its core businesses.
Since the stock is selling for $37 at the time of writing, passive income investors pay only 8.6x free cash flow for Verizon Communications’ 7% dividend yield (the implied FCF multiple for AT&T is 7.0x, but passive income investors also get a higher yield). The yield is obviously backed by more than sufficient free cash, which in turn is derived from a growing base of 5G and fiber subscribers.
Like AT&T, Verizon Communications is a high FCF stock, meaning the company might not see a lot of per-share profit growth, but its free cash should remain sufficient to ensure that the 7% dividend yield is covered.
Verizon Communications Is A Steal
Verizon Communications is selling at an 8.1x earnings multiple, though passive income investors should not expect too much from the Telco in terms of profit growth. Even a moderate or large increase in the company’s valuation multiple should not be expected as the Telco still shoulders a lot of debt that is probably acting as an anchor to Verizon Communications’ valuation.
The Telco’s 8.1x P/E ratio, improved dividend coverage QoQ, and a covered 7% yield make VZ a steal for me, though AT&T is even cheaper (but has a lower yield). Any P/E ratio below 10x for a high-yielding passive income stock is a bargain in my book, which is why I am confident that Verizon Communications has the potential to outperform moving forward.
AT&T sells for 6.7x earnings and throws off a 6.8% dividend yield for passive income investors, so, frankly, I think that Verizon, despite its lower dividend coverage, is a better passive income investment right now.
A buyer purchasing stock of Verizon Communications today gets to collect a 7% dividend yield and the Telco is actively growing its dividend payout.
In What Respect Could An Investment In Verizon Communications Underperform Or Disappoint?
Every investment, no matter how safe the dividend appears to be and how good the dividend coverage ratio looks, has risks. The fact that high-yield Telcos are not growing by a lot isn’t even the biggest headwind, in my view.
Rather, I would point to the generally high levels of debt that are weighing on the Telco sector. Verizon Communications’ balance sheet as of the end of the third quarter showed $134.4 billion in long-term financial debt + $13.0 billion in short-term debt (debt that matures within the next year), which is a problem that could hold back the Telco’s stock price.
My best guess at this point is that the Telco will pay down its debt slowly, but steadily, so as to remove a headwind from the company’s valuation. Thus, passive income investors may want to pay attention to Verizon Communications’ total debt levels and track the quarterly progress the Telco is making in terms of repaying its debt.
The speed of debt repayments, in my view, could make the biggest impact on the company’s stock price trend and lead to the recognition of Verizon Communications’ underlying free cash flow value.
My Conclusion
Verizon Communications has a better margin of dividend safety following the free cash flow forecast upgrade and might be a better Telco high-yield investment than AT&T, despite similar underlying business trends in broadband.
Recent stock price weakness is another solid entry opportunity for long-term investors, in my view, particularly because I see no slowing momentum in the company’s broadband segment.
Taking into account that Verizon Communications has better dividend coverage and that the stock is a steal, I think the risk/reward relationship remains quite compelling. Long-term investors may want to consider buying the dips along the way and reinvest their (growing) dividends as well.
