The largest U.S. mobile service provider Verizon Communications Inc. (VZ - Analyst Report) has made a good start to the year, generating double-digit earnings and cash flow growth in the first quarter of 2012.
First Quarter Review
Verizon’s first quarter adjusted earnings outpaced the Zacks Consensus Estimate by a penny and were 8 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. Rapid expansion of 4G Long-Term Evolution (LTE) services and strong adoption of Google Inc.’s Android smartphones led to the growth in retail wireless subscribers. Though the slowing growth in the U.S. mobile market led to the lower sales of Apple Inc.’s (AAPL - Analyst Report) iPhone, it boosted margins in the segment as subsidies fell.
Despite the solid momentum for FiOS fiber-optic network and strategic services, Wireline revenue dipped on lower global wholesale and other businesses. The penetration rate of both FiOS Internet and FiOS TV accelerated to approximately 36.4% and 32.3%, respectively.
Coming to liquidity, Verizon’s cash balance has reached to less than half of $14 billion and debt rose by a significant $4 billion during the quarter.
(Read our full coverage on this earnings report: Verizon Outperforms, Adds Users)
Despite the ongoing efforts to expand and improve both 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
The covering analysts have mixed views for the second quarter, as depicted by their estimate revisions. Out of 26 analysts, 10 made positive revisions while 10 moved in the opposite direction over the last 30 days.
However, estimates reflect a positive bias for both fiscal 2012 and 2013 over the last 30 days. For fiscal 2012, 14 analysts out of 31 made upward revisions while 10 moved in the opposite direction. For fiscal 2013, out of the 29 covering analysts, 11 revised their estimates downward while 5 revised theirs positively.
The analysts believe that Verizon will see improved revenue and earnings based on both its wireless and wireline businesses. Verizon is experiencing solid momentum in its wireless business, as subscriber additions remains strong with a lower 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 - Analyst Report) and Sprint Nextel Corp. (S - Analyst Report) in terms of 4G deployments, which reached 230 markets covering more than 200 million people as of April 19. Verizon expects to expand its 4G networks to 400 markets by the end of this year and the entire nationwide 3G footprint by mid next year.
Further, the company will continue to achieve wireless growth and profitability with a focus on gaining share in the retail post-paid market, increasing the penetration of smartphones, and selling more Internet devices such as tablets.
In the Wireline business, Verizon will continue to improve long-term profitability by increasing FiOS penetration and strategic service offerings such as manage network, data center, security solutions, cloud and IT infrastructure as well as rationalizing its wireline cost structure.
However, some analysts are concerned about Verizon’s potential spectrum deal setbacks. The company is facing stiff opposition regarding its spectrum deals with a group of cable companies, including Comcast Corporation (CMCSA - Analyst Report), Time Warner Cable Inc. (TWC - Analyst Report) and Bright House Networks, as well as Cox Communications Inc.
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 second quarter remained stable over the last 7 and 30 days at 63 cents.
The Zacks Consensus Estimate for 2012 is $2.49, unchanged over the last 7 days but a penny higher in the last 30 days. Similarly, the Zacks Consensus Estimate for 2012 is stable at $2.78 over the last 7 days but a penny above 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. Verizon produced a positive average earnings surprise of 1.75% 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 surprised us by reporting earnings 3.51% higher than what we had expected.
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, heavy 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.