The largest U.S. mobile service provider Verizon Communications Inc. (VZ) generated double-digit earnings growth and significant cash flow growth once again in second quarter 2012.
Second Quarter Review
Verizon’s second quarter adjusted earnings of 64 cents were in line with the Zacks Consensus Estimate and 7 cents above the year-ago earnings. Revenue improved on continued strong wireless, FiOS fiber-optic and strategic services.
Wireless revenue advanced on the back of strong data revenues and subscriber growth. Despite the slowing growth in the U.S. mobile market, rapid expansion of 4G Long-Term Evolution (:LTE) services, strong sales of Apple Inc.’s (AAPL) iPhone and increased adoption of Google Inc.’s (GOOG) Android smartphones led to the growth in retail wireless subscribers.
In the wireline segment, momentum for the FiOS fiber-optic network and sale of strategic service in the U.S. remained strong. The penetration rate of both FiOS Internet and FiOS TV accelerated to approximately 36.6% and 32.6%, respectively. Nevertheless, revenue fell on continued decline in global business.
Coming to liquidity, Verizon’s cash balance decreased to $10 billion from $13.4 billion at the end of 2011 and debt rose by $0.6 billion in the first half. Net debt-to-adjusted EBITDA remained stable at 1.2 times with year-end 2011.
(Read our full coverage on this earnings report: Verizon Meets Ests, Grows Y/Y)
For 2012, the company expects to generate double-digit earnings growth of 10% on continued healthy wireless margins and improving wireline margins.
Despite the ongoing efforts to expand and improve wireless and wireline networks, Verizon continues to focus on maximizing free cash flow. Management expects capital efficiency (capital expenditure-to-revenue ratio) to continue showing steady improvements; i.e. the ratio will decline throughout the year.
Agreement of Analysts
Estimates reflect a positive bias for the third quarter, fiscal 2012 and 2013 over the last 30 days.
For the third quarter, out of 26 analysts, 17 made positive revisions while 6 moved in the opposite direction over the last 30 days. For fiscal 2012, 11 analysts out of 31 made upward revisions while 10 moved in the opposite direction. For fiscal 2013, out of the 30 covering analysts, 18 revised their estimates upward while 5 made downward revisions.
The analysts believe that Verizon will see improved revenue and earnings in both wireless and wireline businesses. Verizon is experiencing a solid momentum in its wireless business, as subscriber additions remain strong with a low churn rate (customer switch to competitor), in fact the lowest in the industry.
The company is way ahead of its major rival AT&T Inc. (T) and Sprint Nextel Corp. (S) in terms of 4G deployment, which reached 337 markets covering more than 200 million people (nearly 75% of the U.S. population) as of July 19. Verizon will continue to expand 4G networks and expects to reach the entire nationwide 3G footprint by the middle of next year.
Further, the company will continue to achieve wireless growth and profitability from its focus on gaining share in the retail post-paid market, increasing the penetration of smartphones, and selling more Internet devices such as tablets. Besides, Verizon has adopted a new shared data strategy, which is considered the biggest innovation in wireless pricing over the past several years. The new strategy — Share Everything — will maximize the carrier’s revenue over the long term. All these developments and operating efficiencies would help Verizon to reduce $2 billion in costs this year, thereby driving more profitability in the business.
In the wireline business, Verizon continues to improve long-term profitability through product streamlining and process simplification initiatives as well as cost management actions. Some analysts believe that though these measures will lead to improved revenue, high operating margins and greater market share in the long term, it might dilute short-term revenue and margins.
In addition, the company’s wireline division is currently struggling with persistent losses in access lines that are weighing on its revenues and margins.
Further, analysts are concerned about Verizon’s potential spectrum deal setbacks. The company is facing stiff opposition to its spectrum deals with a group of cable companies, including Comcast Corporation (CMCSA), Time Warner Cable Inc. (TWC), Bright House Networks, as well as Cox Communications. It will have an adverse impact on Verizon’s financials should the deal fail. But if it succeeds, it might put pressure on the balance sheet in the short term, by reducing cash balances and increasing capital expenditures before becoming accretive over the longer term.
Magnitude — Consensus Estimate Trend
The magnitude of revisions for the third quarter is 68 cents, unchanged over the last 7 days but 2 cents higher in the last 30 days.
The Zacks Consensus Estimate for 2012 remained stable over the last 7 and 30 days at $2.50. Similarly, the Zacks Consensus Estimate for 2013 remained unchanged at $2.81 over the last 7 days but was raised by 2 cents in the last 30 days.
With respect to earnings surprises, the company’s fairly good track record is expected to continue in the coming quarters. Verzion produced a positive average earnings surprise of 0.81% over the last four quarters, indicating that it outpaced the Zacks Consensus Estimate by that amount over the last year.
In the recently concluded quarter, the company did not surprise us by reporting earnings in line with our expectations.
Fiscal 2012 is expected to be profitable for Verizon considering the promises in both wireless and wireline businesses. Moreover, the company aims to enhance shareholder value throughout the year.
However, we remain skeptical about returns from the 4G wireless and wireline FiOS networks, persistent access line losses, iPhone subsidies, hindrances in spectrum deals and intense competition from cable companies and other alternative service providers.
We are currently maintaining our long-term Neutral rating on Verizon. For the short term (1–3 months), the stock retains a Zacks #3 (Hold) Rank.
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