As a rough autumn is turning into a downright nasty holiday season for U.S. stock market investors, one Dow Jones Industrial Average component has largely avoided the carnage. Not only has Verizon Communications (NYSE:VZ) generally shrugged off the correction that started in October, VZ stock is up more than 5%.
The shares start the trading week up 7.75% for the year, compared to the DJIA’s 1.75% decline, demonstrating how investors have found safe harbor in the storm. Still, many are wondering if the communications giant can maintain its strong outperformance going into 2019.
Interest Rates Turning In Verizon’s Favor
One of the issues for defensive stocks — utilities and telecoms, such as Verizon — has been rising interest rates. The Fed’s consistent tightening policy since late 2016 has pushed short-term interest rates up. On the long end of the yield curve, investors have sold bonds in anticipation of a stronger economy, which will likely contribute to mounting inflation.
However, this narrative has broken down over the past few months. For one thing, strong domestic economic gains look increasingly isolated. For the year, virtually all foreign stock markets are now in the red in dollar terms. Commodity prices, which are closely correlated to the global GDP outlook, have slumped. Even in the U.S., some indicators, such as auto sales and housing prices, are showing weakness.
This is bad news for the market, but good for Verizon. For one thing, Verizon has a ton of debt. As of latest filings, it totals around $110 billion. That’s up sharply from around $50 billion just five years ago. Verizon, like many firms, took advantage of cheap money to expand its business. Now, however, rising interest rates could hit the company’s profits; in theory every 1% rise in its average interest rate on its debt would cost the firm more than $1 billion a year in profits.
Additionally, the yield on the VZ stock dividend is still an attractive 4.2% despite the recent rally. Should long-term interest rates keep rising, though, that now-attractive yield could lose some of its allure. Earlier this year, the risk-free, 10-year Treasury bond yield hit 3.2% and many analysts were forecasting it could keep increase to 3.5% or even 4%, which would not have been good news for Verizon investors. As it happens, that benchmark rate has gone the other way, slumping to just 2.87% as of this writing.
Verizon Shares Safer Than AT&T
Another big part of Verizon’s success in 2018 is that its major rival has been in the news. AT&T (NYSE:T) stock has dropped from as high as $39 to $30 this year, and is down almost 22% year-to-date. It’s not hard to see why.
AT&T took on a huge amount of debt to complete its mega-merger with Time Warner. By some accounts, AT&T is now the most-indebted company in the world. That has severely tarnished AT&T’s reputation as a sleep-well-at-night widows-and-orphans stock.
AT&T now has nearly $190 billion in debt. And given its commitment to paying $14 billion a year in dividends to its shareholders, that doesn’t leave it a ton of cash flow wiggle room. It’s planning to sell off assets to reduce its debtload. However, the Department of Justice isn’t prepared to give up on its antitrust case against the AT&T/Time Warner merger, filing a rare appeal against the initial decision permitting the deal. The DOJ claims that the judge in that case ignored “fundamental principles of economics and common sense”.
At this time, it’s anyone’s guess how the new look AT&T will play out. If the Time Warner deal works and they get a competitive streaming service/digital content strategy, T stock could be a big winner. Or the merger could fizzle, like the infamous Time Warner/AOL deal at the turn of the century. If that happens, AT&T might need to cut their dividend and VZ stock would continue getting a defensive bid from investors wanting access to the safer big U.S. telecom stock.
VZ Stock: Rock Solid, But Don’t Expect Big Upside
At $45 a share, you could make a good case for VZ stock as a deep value. Closer to $60, it’s still a safe haven, but most of the upside potential is gone in the short run. VZ stock trades at 7.3x trailing and 15x forward earnings, which is a fair valuation, but hardly cheap.
Telecom and utility stocks almost never trade at high PE ratios as earnings growth potential is so limited. Analysts see roughly 5% a year earnings growth over the next five years, which would actually be fairly good for Verizon. Still the market isn’t going to ever pay much more than 15x earnings for that rate of EPS growth.
Bulls have a few positive signs to look to. For one, Verizon has aggressive plans to shave $10 billion in costs over the next four years, and so far, management appears to be on track with this plan. Additionally, the company has an edge in 5G deployment that may help it somewhat in the mobile business. Still though, don’t be surprised if VZ stock has a quiet year in 2019, keeping you safe from market storms but not rallying that much farther on top of this year’s gains.
At the time of this writing, Ian Bezek held no position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
