This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
The U.S. stock market has performed relatively well over the course of 2020, despite the broad economic downturn caused by the coronavirus. The S&P 500 Index is up by less than 1%, and while this is normally not an impressive rate of return, it is somewhat surprising given the extremely difficult economic backdrop.
Despite the resilience of the S&P 500, many individual sectors remain under pressure. In recessions, investors need to make sure the dividend stocks they are buying have sustainable payouts, backed by strong business models that can generate cash flow regardless of the economic climate.
We believe Verizon Communications (VZ) is a high-quality dividend stock with a recession-proof dividend. Verizon currently yields over 4%, and recently increased its dividend signaling management’s confidence in the long-term direction of the company.
Business Overview and Recent Events
Verizon is the largest telecommunications company in the United States by market capitalization. Verizon is a mega-cap stock with a market cap above $250 billion. Verizon is a diversified telecommunications provider of wireless, broadband, and cable. The company’s wireless network covers ~300 million people and 98% of the United States.
As a major telecom, Verizon has not been immune from the coronavirus pandemic but the impact has been relatively muted. In the most recent quarter, Verizon’s revenue decreased 5% to $30.4 billion, but beat analyst estimates by $420 million. Adjusted earnings-per-share declined $0.05, or 4.1%, to $1.18, but was $0.03 ahead of estimates. Wireless revenue was down a relatively mild 1.7% to $15.9 billion.
Verizon continues to benefit from its industry-leading network. Total retail postpaid net additions totaled 352,000 last quarter. Churn remained very low at 0.78%. For the full year, Verizon management has issued guidance which calls for flat adjusted earnings-per-share at the midpoint of the forecast. This would normally be a poor performance, but in the context of the recession and coronavirus crisis, Verizon’s results are not that bad.
While 2020 is expected to be a difficult year, we expect the company to generate long-term growth due to its leadership at the top of the wireless industry. Verizon is able to charge higher prices than its competitors in wireless service, which is possible due to the company’s industry-leading network. The result of this is that Verizon generates strong cash flow. Over the first half of 2020, Verizon generated free cash flow of $13.7 billion, up from $7.9 billion in the first half of 2019. Such strong free cash flow can be deployed to invest in growth, pay down debt, and return cash to shareholders.
On the topic of growth, Verizon has invested heavily in new strategic areas to drive future growth. One of these areas is 5G rollout. Verizon has expanded its Ultra-Wideband 5G service to nearly 60 cities, with further rollouts planned in the near future. This will enable Verizon to reap revenue growth through higher average revenue per user, both for consumers and business customers. Verizon’s Business Group expects to launch 10 5G Mobile Edge Compute sites this year.
Acquisitions are an additional growth catalyst, such as the recent $6.25 billion purchase of Tracfone from America Movil (AMX). Tracfone is a leading pre-paid and value mobile provider in the United States with approximately 21 million subscribers. The deal instantly expands Verizon’s subscriber count, with opportunities for enrollment in other related services.
Verizon has a number of competitive advantages, specifically its dominant position in the U.S. wireless industry, which will help the company generate long-term growth. It is also a recession-resistant company. Verizon operates a virtually recession-proof business model. Consumers are simply unwilling to go without their wireless and Internet service, which gives Verizon a highly reliable level of demand from year to year, even during recessions.
Valuation & Expected Returns
We expect Verizon to generate adjusted earnings-per-share of $4.81 for 2020. Based on this, the stock has a P/E ratio of 12.2. Our fair value estimate is a P/E ratio of 13, which means the expansion of the valuation multiple could boost annual returns by 1.3% per year. Shareholder returns will also be fueled by earnings-per-share growth and dividends. We expect 4% annual EPS growth over the next five years, comprised mostly of revenue growth and share repurchases.
Lastly, Verizon has a high dividend yield of 4.3% which is especially attractive for income investors. The S&P 500 Index yields less than 2% on average right now, meaning Verizon stock offers more than double the dividend income of the broader S&P 500 Index. Verizon also raises its dividend on a regular basis. Dividend raises are one of the key differentiators that are appealing to income investors when comparing stocks and bonds. The company has increased its dividend for 14 consecutive years, including a recent 2% dividend hike on September 3.
The combination of an expanding P/E multiple, earnings-per-share growth, and dividends results in total expected returns of 9.6% per year over the next five years. This is a satisfactory rate of return for a steady blue-chip dividend stock.
The stock market has recovered off of its lows for the year, but the U.S. economy is by no means out of the woods. The economic environment still remains extremely challenged, with multiple industries such as retailers, restaurants, and energy still struggling. Many stocks in these sectors have cut or suspended their dividends over the course of 2020.
Verizon is a high-quality company with a strong brand and a recession-proof business model. The company should continue to generate enough cash flow to reward shareholders with a large dividend, along with modest dividend increases each year. With a modest valuation and a dividend yield over 4%, we believe Verizon is an attractive stock for value and income investors.