Marcial: Are Bulls Hanging Up on Verizon?

At an investor conference hosted by Goldman Sachs (GS) on Sept. 17, top executives of big telecom outfits expressed mixed sentiments about the economic recovery but were upbeat about the outlook for the industry. One of them was Verizon Communications (VZ) Chairman and CEO Ivan G. Seidenberg, who noted that the company weathered the recession better than its peers as it aggressively acquired wireless assets and shed some underperforming wireline operations.

Indeed, Verizon's stock continues to garner some decent support on Wall Street, with 53% of the 32 analysts who track the telecom giant rating it a buy and 44% recommending holding the stock, according to Bloomberg data. So far only one analyst rates it a sell. The stock, which traded as high as 44 a share last year, has fallen to 29, although it is holding above its 52-week low of 23 reached on Oct. 10, 2008.

But some of the bulls appear to be having second thoughts. A few analysts have recently downgraded the stock to neutral from buy, citing concerns about deteriorating industry fundamentals.

One of them is John C. Hodulik of investment firm UBS (it has done business with and banking for Verizon), who scaled back his Verizon earnings estimates for 2009 and 2010. As Verizon's sales from its business customers "continue to worsen" and aren't likely to improve until 2010, "we now expect Verizon to miss its annual guidance for [earnings-per-share] growth in 2009 due to continued pressure on its wireline business," says Hodulik. And "cracks are beginning to appear," he warns, in Verizon's robust wireless business.

Pressure Remains on Enterprise Business Verizon is one of the largest providers of wireline, wireless, and Internet broadband services. Through its joint venture with Vodafone Group (VOD), the company is the largest U.S. wireless carrier, serving 87.7 million customers. Alltell, which Verizon acquired in January 2009 for $28 billion, contributed 13 million subscribers.

"We no longer expect wireless [average revenue per user] to grow in the third quarter after the below 1% growth in the first half," says Hodulik.

Another analyst who recently downgraded Verizon's stock to neutral from buy is Chandan Sarkar of investment firm Auriga USA. "Our downgrade suggests continued underperformance relative to the rest of the market," says Sarkar.

He also cut his earnings estimates for Verizon as he expects continuing pressure on the company's enterprise business to weigh down earnings in the second half of 2009. Because of the ongoing layoffs by U.S. businesses, Sarkar cautions that enterprises aren't expected to upgrade their phone network services. So he doesn't expect Verizon's revenues from corporations and businesses to pick up for several more quarters.

As a result, Sarkar expects revenues and margins to be squeezed, prompting him to cut his earnings for the third and fourth quarters of 2009, as well as his yearly estimate for 2010.

For all of 2009 he expects Verizon's earnings to fall to $2.46 a share, from 2008's $2.55. And for 2010, Sarkar rolled back his estimate from $2.67 to $2.58.

Wireless Growth Could Drag, Too Sarkar also cautions that intense competition in the international market could make a dent in Verizon's sales and earnings. He says aggressive promotional pricing abroad by Cablevision (CVC), Vonage (VG), and MetroPCS (PCS) "signal that profits from international long-distance business will likely come under margin pressure."

At UBS (UBS), analyst Hodulik warns there could be further downside in Verizon's wireless annual revenues given the ability of Apple's (AAPL) iPhone to attract high-end subscribers to AT&T (T), the smartphone's exclusive U.S. provider. Sprint (S) and T-Mobile are also making efforts to turn their businesses around, notes the analyst. Putting it all together, growth in the company's most promising segment—wireless—is apt to drag. "We estimate wireless service revenue growth will slow from 9% in the second quarter to 6.8% in the third quarter, and to 5.7% in the fourth quarter," figures Hodulik. And he doesn't expect any better in 2010, when he estimates growth of just 5% driven by a 4.3% subscriber increase and a 0.6% uptick in average revenue per user.

From here, "we think Verizon's stock will be range-bound," says Hodulik, "as the market absorbs the lower EPS outlook for 2009-2010." The analyst has reduced his 12-month stock price target to 32 from 34.

What do the bulls have to say? They argue that Verizon will remain ahead of its peers in attracting or adding new customers. Todd Rosenbluth, an analyst at Standard & Poor's who rates Verizon a buy with a 12-month target of 35, says one of the positives is the company's hefty dividend yield of 6.08%, which he says is "secure and well supported [by] its cash flow and capital spending discipline."

There is little doubt, however, that concerns are rising about the industry's outlook. "This year is playing out as another challenging one for the telecoms," notes analyst David M. Reiner of independent investment research outfit Value Line (VALU). With growth questions lingering, whether to purchase Verizon shares is not an easy call at the moment.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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