Insights

At a 5-Year Low, Is Verizon Communications Stock a Buy?

Verizon Communications(NYSE: VZ) stock price sank 7% and hit a five-year low on July 22 after the company posted a messy second-quarter earnings report. The telecom giant’s revenue remained flat year over year at $33.8 billion, which met analysts’ expectations. But its adjusted earnings declined 6% to $1.31 per share, which missed Wall Street’s estimates by a penny.

Those headline numbers didn’t seem too bad, but Verizon gained a mere 12,000 net new postpaid phone subscribers during the quarter, which broadly missed the consensus forecast for over 167,000 net adds. That slowdown prompted Verizon to significantly reduce its guidance.

Image source: Getty Images.

Instead of 9%-10% growth in wireless service revenue for the full year, it now expects just 8.5%-9.5% growth. As for the core “service and other” segment, which generated 80% of its second-quarter revenue, it now predicts a 0%-1% decline, compared to its prior forecast for flat growth.

On the bottom line, Verizon sees its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) slipping 0%-1.5% for the full year, compared to its prior forecast for 2%-3% growth, and for its adjusted EPS to decline 3%-5%, compared to its prior target for 0%-3% growth.

Simply put, Verizon’s near-term growth has stalled out. Should investors consider the stock an undervalued dividend play at these levels, or is this blue-chip telecom stock becoming a high-yield trap?

Unfavorable comparisons to AT&T

Verizon’s numbers look even worse when we compare them to AT&T‘s (NYSE: T) latest report.

In its second quarter, AT&T gained 813,000 postpaid phone net adds, which represented its wireless segment’s strongest second-quarter subscriber growth in over a decade. Its postpaid phone churn of 0.75% also came in slightly lower than Verizon’s postpaid phone churn of 0.81%.

AT&T then raised the full-year revenue forecast for its wireless segment from “3% or better” growth to 4.5%-5% growth. It also reiterated its previous guidance for the full year, which called for its revenue to rise by the low single digits, its adjusted EBITDA to grow 2%-4%, and its adjusted EPS to increase 0%-2%. AT&T still ranks third in the U.S. wireless market after Verizon and T-Mobile, but its recent growth spurt coincides with Verizon’s slowdown and raises a bright red flag for the market leader.

How did Verizon explain its recent slowdown?

During the conference call, CEO Hans Vestberg mainly attributed Verizon’s slowdown to inflationary challenges for consumers, as well as “intensified competition” across the wireless market.

Vestberg said Verizon was already responding to those threats with its new “Welcome Unlimited” plan — which offers unlimited text, talk, and data for $30 per month — for “budget-conscious” consumers. It’s also been raising prices for its legacy metered plans, and it continues to leverage its “Mix & Match” plans to lock customers into more services. Vestberg says Verizon is already “executing to reaccelerate in the second half of the year,” but its grim guidance points to a sluggish turnaround.

On the bright side, its broadband business still gained 268,000 net additions during the second quarter. But it’s still growing slower than AT&T Fiber, which gained 316,000 net adds last quarter.

Investors should brace for lower margins and profits

Verizon’s operating margins fell year over year across both its consumer and business segments. It mainly pinned that contraction on competitive headwinds, elevated promotional spending, higher device subsidies, its divestment of Verizon Media (which had housed its higher-margin digital advertising businesses), lower wireline revenue, and inflationary cost pressures.

Analysts had already expected Verizon’s operating margin to decline by 130 basis points to 23% in 2022, but its recent guidance cut suggests those estimates could be too optimistic.

Is it becoming a high-yield trap?

At $45 a share, Verizon’s stock trades at just nine times its revised EPS forecast for 2022. It also pays a hefty forward dividend yield of 5.8%, and it can easily cover those payments with a forward payout ratio of less than 50%. However, AT&T trades at seven times forward earnings, pays a higher forward yield of 6%, and will likely grow faster than Verizon this year.

I wouldn’t call Verizon a high-yield trap yet, since it’s firmly profitable and can easily cover its dividends. It also usually holds up well during bear markets and recessions. But I wouldn’t consider it a bargain after its latest guidance cut — which strongly suggests that AT&T might actually be the better telecom play right now for income-oriented investors.

Leo Sun has positions in AT&T. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.

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