Earnings Preview: Verizon

The largest U.S. mobile service provider Verizon Communications Inc. ( VZ - Analyst Report ) is slated to release its second quarter 2012 earnings on July 19, before the opening bell. The current Zacks Consensus Estimate is pegged at 63 cents for the second quarter, representing a year-over-year increase of 11.34%.

With respect to surprises, Verizon had a 1.75% average positive earnings surprise in the trailing four quarters. In the year-earlier quarter, the company had surprised us by reporting earnings 3.64% above our expectation.

The company did not release any financial forecast for the second quarter during its first quarter conference call.

First Quarter Flashback

Verizon made a good start to the year, producing double-digit earnings and cash flow growth. Lower sales of Apple Inc.’s ( AAPL - Analyst Report ) iPhone boosted margins during the quarter as subsidies fell.

Adjusted earnings were a penny ahead of the Zacks Consensus Estimate and 8 cents above the year-ago earnings. Revenue improved on continued strength in wireless, FiOS fiber-optic and strategic services.

Wireless revenue advanced on the back of strong data revenues and subscriber growth. Despite the sluggish growth in the U.S. mobile market, rapid expansion of 4G LTE services and strong adoption of Google Inc. (GOOG) Android smartphones led to the growth in retail wireless subscribers.

Despite the solid momentum for FiOS fiber-optic network and strategic services, Wireline revenue dipped on continued declines across global wholesale and other businesses. The penetration rate of both FiOS Internet and FiOS Video accelerated to approximately 36.4% and 32.3%, respectively.

Agreement of Analysts

Estimates reflect a negative bias for both the second quarter and fiscal 2012 over the last 30 days. For the second quarter, 3 analysts out of 26 made downward revisions while none moved in the opposite direction. For fiscal 2012, out of the 31 covering analysts, 3 revised their estimates downward while 1 revised it positively.

The analysts are cautious on both the company’s wireless and wireline divisions. Verizon is spending hugely to subsidize the iPhone, which will likely limit its wireless margins and profits throughout the year.

Verizon is facing major setbacks 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 and 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.

On the wireline front, Verizon is struggling with persistent losses in access lines that are weighing on its revenues and margins. However, the company is currently making efforts to reduce its wireline cost.

Moreover, the analysts believe competitive pressures from its largest rivals AT&T Inc. ( T - Analyst Report ) and Sprint Nextel Corp. ( S - Analyst Report ) , and high promotional and restructuring expenses would further limit the earnings upside potential.

The analysts believe these negatives would offset Verizon’s strong subscriber count and average revenue per user, which depend on penetration of smartphones and iPhones, in the U.S. market in particular.

Magnitude — Consensus Estimate Trend

The magnitude of earnings revisions for the second quarter increased by a penny in the last 7 and 30 days.

The Zacks Consensus Estimate for 2012 remains unchanged at $2.50 over the last 7 and 30 days.

Neutral Recommendation

We believe Verizon is poised to grow its revenue and earnings based on the introduction of smartphones, tablets and data devices in the wireless segment and continued expansion of robust FiOS fiber-optic network and strategic services, including cloud-computing business, in the wireline business. These will continue to drive the company’s growth prospects going forward.

However, persistent erosion in access lines, uncertain returns from the 4G wireless and wireline FiOS networks, iPhone subsidies, hindrances in spectrum deals and intense competition from cable companies and other alternative service providers are threats to the stock.

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.