Introduction

2023 hasn’t been a particularly rewarding year for the shareholders of Verizon Communications (NYSE:VZ); on a YTD basis, the stock has only managed to eke out marginal single-digit returns, substantially lower than what the broader markets have delivered.

However, when one reviews some of the underlying developments at VZ, and also considers the outlook ahead, we think the return profile could change for the better. Here are three broad reasons why we feel Verizon would represent a good investment at these levels.

Valuations Look Compelling, Given The Ongoing Execution On The Operating Front

Firstly, we’d like to start by saying that even though the stock has moved up in recent months, we still believe it offers compelling value. On a forward EV/EBITDA basis, it can still be picked up at a ~10% discount to its 5-year average multiple.

Given some of the ongoing operational improvements, we think this is a wonderful opportunity to pick up a business on the cheap.

This is a business that has been implementing pricing improvements to great success over the last couple of years. In FY22 they incorporated $2bn worth of pricing changes, and this year they’ve brought through another $1bn (including one more recently in September which could add $100m of benefits through Q4 and beyond), the benefits of which are expected to linger over the next few quarters. In a price-sensitive environment such as what we have now, one would have thought there would be a spike in churn levels, but rather it has been very controlled (for instance postpaid churns have remained stable at 0.85%).

Even with the Fixed Wireless Access (FWA) portfolio, we’ve seen VZ lift pricing by $10 for new bundled customers, but this has not prevented the business from continuing to meet its net addition target run-rate of 350-400K per quarter (the goal is to eventually get to 4-5m subs in another couple of years).

Part of the reason why we’re seeing such strong stickiness is because of the influx of C-band and the enhanced speed that customers are getting which could also prompt a shift to premium plans. Management believes that peak speeds in urban areas are now at 2.4GHz. Crucially, as things stand, C-band has been rolled out in roughly only half their cell sites so there’s still plenty of runway left.

Then while the legacy business wireline business still remains a drag, management has noted that they are no longer pursuing low-margin deals here. Additionally, one shouldn’t dismiss the impact of Verizon’s ongoing cost savings plan where they’re looking to bring down the cost base by $2-$3bn by FY25, which should provide some very useful operating leverage.

One can get a sense of this through the progression of sell-side estimates all through FY25. Now as per YCharts estimates between FY22-FY25, the topline could likely only grow at 0.2% (lingering impact of the legacy wireline business), but the EBITDA CAGR for that period will be 5x higher at 1%.

The Dividend Sub-plot Is Still Burning Bright, As Cash Generation Picks Up

Besides the core story, we think VZ’s stock also offers a compelling proposition for income-chasing investors. Verizon has a fairly long history of growing its dividends for 17 years on the trot (most of the other stocks in this industry have barely been able to keep it up for beyond a year), and over the last three years it has been growing at a decent pace of roughly 2% p.a. Given where the stock is currently, investors can lock in an excellent yield figure of 6.82%, almost 300bps better than the stock’s 5-year average.

We also don’t foresee any major risks in VZ’s ability to keep up the pace of its dividend growth going forward as the FCF (free cash flow generation) has really stepped up this year.

Earlier, we touched upon some favorable occurrences linked to VZ’s pricing and cost savings strategies, but besides that, VZ management has also noted how working capital is facing less stress on account of longer handset replacement cycles associated with postpaid consumers. Over the last couple of quarters, upgrade volumes have been down by -30% to -20% levels, and this is something that management believes will linger for the next few quarters.

Then you have some very encouraging developments on the CAPEX front; this time last year, the company was deploying hefty sums to the tune of over $7.2bn on CAPEX, but every quarter since we’ve seen a marked step-down. As a result, the level by which the operating cash flow is covering CAPEX has almost doubled from the levels seen at the end of last year.

Last week, management confirmed that the core build associated with the One Fibre Program is now drawing to a close and the expectation is that the FY CAPEX for this year will likely only come in at around $19bn, which is a good $4bn lower than what we saw last year. Crucially next year, CAPEX will see another step down, to lower levels around $17bn.

All in all, we think the FCF prospects look very encouraging. Already on a FCF yield basis, the stock already provides a figure that is more than double the 5-year average of 3.55%.

With strong FCF-generating potential, we think the dividends are well covered. It’s also worth noting that relative to its closest peer- AT&T (T), VZ’s distribution of its FCF to its shareholders is almost twice as much as what the former does with its FCF.

Even after fulfilling a 2% dividend growth rate, VZ should still have enough in its tank to continue to pay down its debt, something which we’ve already seen, with the total net debt figure coming down over the last couple of quarters. Needless to say, as this continues to trend lower, VZ’s stock value quotient under the EV/EBITDA metric will only look more tantalizing. Note that the company’s leverage ratio currently stands at 2.6x, and the goal is to get this down to levels of 1.75-2x, although if they bring it down to 2.25x, investors can also be enthused about the prospect of buybacks coming back to the table. For the uninitiated, there’s a 100m share buyback program that has already been authorized but is yet to kick off.

Closing Thoughts- Good Risk-Reward On The Charts

To conclude, we’ll also touch upon some of the favorable turn of events on the charts.

Viewing VZ’s long-term monthly chart we can see that since the second half of 2021, until Q2/Q3 of this year, the price had been in a prolonged slump, trending lower within a steep descending channel. In October we saw the stock form a bottom at around the $30 level, whilst we’ve also seen a breakout from the prolonged descending channel. Now if you take a step back and view the broad trading range ($30-$60) over the last eight years, we certainly think an entry at these levels represents good risk-reward.

Another reason why we feel there’s still ample upside runway is because of how VZ’s stock is positioned relative to its peers from the Communication services sector.

To elaborate on this, we basically feel that prospective investors fishing for suitable rotational opportunities in the communication services segment will likely have VZ as one of the top names on their watchlists; note that even though we’ve seen a recovery, the relative strength ratio as a function of an equally weighted comm services portfolio is still around 22% off the mid-point of its long-term range. Don’t rule out the prospect of some mean reversion in this ratio.