Verizon Communications (NYSE:VZ) is a solid dividend stock that is at a crossroads. It has somehow managed to stay afloat in the world of mobile communications, while generating great cash flow, and thus being able to pay what is now 4.9% dividend.
However, with consolidation going on between telecom companies and content providers, Verizon is currently out in the cold. In addition, now that merger talks are back on between T-Mobile Inc. (NASDAQ:TMUS) and Sprint Corp (NYSE:S), should investors be worried that Verizon isn’t part of the fun?
Verizon had a troubling year in 2017. Revenue went flat and earnings fell by a little more than 3%, partly because of service revenue and partly from a decline from wireless. Verizon is currently stuck in a business that is really nothing more than a commodity. Smart phones are ubiquitous, but more importantly, everyone has an unlimited data plan now so there is very little to distinguish among providers, other than service.
Meanwhile, T-Mobile is eating everyone’s lunch.
VZ stock management says not to expect any more than low-single-digit earnings growth this year. Low single-digit EPS growth, even when combined with a generous dividend and terrific free cash flow, makes it difficult to justify its P/E ratio 14.
On the positive side, there is that free cash flow I mentioned. As it is, Verizon pumped out $8 billion of it in 2017, and that may get a boost towards $12 billion, thanks to the recent tax cuts. This extra free cash flow is critical because Verizon has actually not generated enough free cash to pay all of its dividend the past two years.
That free cash flow is also a saving grace for VZ stock, because it can maintain its dividend. However, Verizon is loaded with over $110 billion in debt. The sad truth is that management simply cannot afford to continue raising the dividend while ignoring the debt. The debt has to start getting paid down, and doing it at a rate of $2 billion a year is a drop in the bucket.
Verizon may go nowhere in terms of growth for a very long time under present circumstances. Now, if you’re an income investor, sitting back and collecting a 4.9% dividend isn’t so terrible, provided that Verizon’s underlying business does not deteriorate. But if it does deteriorate, if revenues significantly decline, if expenses start to increase, that means less cash flow can go to the bottom line and therefore to pay the dividend. And right now, I don’t see a whole lot of growth catalyst for Verizon stock.
What may prove to be the difference in the short-to-medium-term is how quickly Verizon will be able to roll out its 5G network. While consumers aren’t necessarily rushing to replace the current smart phone with the newest model, they may rush to Verizon from other carriers if Verizon is out of the gate first and scaling more quickly than the others.
Not only that, consumers may be willing to pay more for 5G service, and if Verizon is the first and best mover in that space, they may get an advantage that could give them some near-term growth catalysts.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
