Verizon Communications Inc. (VZ), AT&T Inc. (T): 4 Reasons the Run in This Stock Should Continue

Page 1 of 2

Investors need to be careful about assuming trends that happened in the past will continue in the future. I recently noticed Verizon Communications Inc. (NYSE:VZ)’s yield drop below 4%, and thought that the stock might have run too far, too fast. In prior years, I was used to seeing Verizon’s yield at around 4% or more. My gut instinct told me that with a lower yield, investors might not be as attracted to the stock. However, after researching the company’s recent earnings, nothing could be further from the truth.

The beat goes on
It seems like anytime AT&T Inc. (NYSE:T) begins to gain an edge on Verizon Communications Inc. (NYSE:VZ), the latter comes out with earnings that are just better in every way. In recent months, I noticed that AT&T was buying back relatively more shares than Verizon, and the company’s yield was higher. However, looking at each company’s earnings, there is little question that Verizon is performing better.

There has also been a lot of talk about Sprint Nextel Corporation (NYSE:S) being bought by Softbank or DISH Network Corp. (NASDAQ:DISH). However, no matter what happens, Sprint isn’t playing in the same league as even AT&T Inc. (NYSE:T). Last but not least, we have T MOBILE US INC (NYSE:TMUS), trying to take the third spot from Sprint. The combination of roughly 9 million Metro PCS customers and about 43 million T-Mobile users makes the company more competitive, but they can’t match Verizon Communications Inc. (NYSE:VZ)’s performance either.

A high margin business
The first reason investors should consider the stock is, Verizon has the best operating margin in the wireless business. In the current quarter, Verizon Communications Inc. (NYSE:VZ)’s wireless operating margin was 32.9%, solidly ahead of AT&T Inc. (NYSE:T) at 28%. Considering that Sprint Nextel Corporation (NYSE:S)’s wireless margin was essentially zero, and T-Mobile managed about 8.38%, you can see the gap in performance between these companies.

Verizon Communications Inc.However, Verizon investors need to be aware that this margin may come under pressure in the future. The continued adoption of smartphones with higher subsidies hasn’t hit Verizon Communications Inc. (NYSE:VZ) full force yet. For instance, AT&T reported that 88% of postpaid subscribers chose a smartphone, and Sprint Nextel Corporation (NYSE:S) reported 86%. By contrast, Verizon reported 85.1% of postpaid subscribers chose a smartphone, yet just 61% of total subscribers were using a smartphone. Considering that AT&T Inc. (NYSE:T) has 72% of its subscribers on a smartphone, you can see Verizon’s customer base has further to go before Verizon is paying subsidies like AT&T is.

Customers are voting with their loyalty
A second reason that Verizon Communications Inc. (NYSE:VZ) is the best comes from its customers. Verizon has routinely had the lowest postpaid wireless churn in the business. Since Sprint Nextel Corporation (NYSE:S) and T-Mobile have many more pre-paid subscribers, their churn is higher and creates an unfair comparison. That being said, Sprint’s postpaid churn rate was 2.09% in the last quarter, and T-Mobile’s churn rate as of late last year was 2.3%.

By comparison, AT&T Inc. (NYSE:T) reported postpaid churn of 1.04%, but Verizon did even better, with postpaid churn of 1.01%. Since Verizon has consistently beat their peers in this area, it seems clear that once a customer switches to Verizon, they don’t leave.

Why would you go against the flow?
Some investors have been unimpressed with Verizon’s earnings, and think that the stock is too expensive. However, those looking at Verizon Communications Inc. (NYSE:VZ)’s net income are missing the point completely. Verizon, like its peers, has a huge amortization and depreciation allowance. This means that net income only tells a part of the cash flow story.

Verizon’s operating cash flow growth is the third reason the stock looks attractive. When looking at cash flow, I eliminate much of the accounting changes and just use what I call core operating cash flow (net income + depreciation). Using this calculation, Verizon stands head and shoulders above their peers. The company grew core operating cash flow by 13.1% on a year-over-year basis, compared to growth of just 1.1% at AT&T Inc. (NYSE:T). Sprint Nextel Corporation (NYSE:S)’s core operating cash flow grew by 5.73%, and T-Mobile’s results are skewed because of the Metro PCS deal.

Page 1 of 2