To The Moon

$Verizon(VZ)$

Good day, Tiger! Verizon's stock has been declining for the past five years, yet its dividend has steadily increased. How can this be? That’s exactly what we’ll explain in this video. We’ll also calculate Verizon's intrinsic value to help you determine if it fits your portfolio. So, let’s dive in.

Over the past five years, Verizon's stock has dropped by 36%. While its dividend yield has partially offset the decline, this performance pales in comparison to the broader market, which has doubled in value over the same period. Verizon’s current market cap stands at $160 billion. In this analysis, we’ll place Verizon on the value investing quadrant, assess its risk and reward profile, and calculate its intrinsic value relative to peers.

The key takeaway: Verizon offers a 7% dividend yield with projected growth of 2.3%. If sustained, this implies a potential 9-10% annual return. As a leader in 5G alongside T-Mobile, Verizon is expanding its fiber network through acquisitions like Frontier. However, this $20 billion acquisition adds to Verizon's already significant debt. Over the past decade, the company has invested $200 billion into 5G spectrum, fiber, and other initiatives. While these investments aim to drive growth, they also contribute to the company's substantial debt load, which weighs heavily on the stock’s performance.

Verizon operates in a fiercely competitive market, with T-Mobile capturing more market share. Revenue growth remains sluggish, with total revenue flat and wireless service revenue increasing only marginally. Cash flows from operations have declined by $2.3 billion, though capital expenditures are also down by $2 billion, maintaining free cash flow stability. This has enabled modest dividend growth, despite the growing debt, now at $170 billion. While manageable for now, this debt is a recurring challenge.

From an investment perspective, Verizon is heavily influenced by interest rates. Rising rates increase refinancing costs on its debt and push up the dividend yield required by the market, which lowers the stock price. Conversely, when rates decline, Verizon’s financials and stock performance improve. Over the past 20 years, Verizon’s dividend has consistently grown, but its dividend yield has risen from 4.29% to 7%, reflecting higher market expectations tied to interest rate increases.

Higher Dividend In Recession?

Why does the market demand a higher dividend? For much of the past decade, interest rates were near zero, making Verizon's 4% yield attractive. With higher interest rates today and expectations for rates to stabilize around 3%, the market now demands a 7% yield. Verizon’s dividend yield typically trades at a premium of around 300 basis points above the risk-free rate, making its large debt burden a critical factor in its valuation.

In summary, Verizon's future hinges on interest rates, debt management, and its ability to maintain modest growth in a competitive environment. Let’s explore its earnings, debt structure, and intrinsic value further to understand the risk and reward it offers to investors.

Risk And Challenges

Looking more closely at Verizon’s debt, it’s clear that it includes a mix of various instruments. Some smaller portions, such as state-level debt, come with relatively high interest rates, but these are minor amounts. The larger sums are more impactful, such as refinancing due in 2025, currently carrying an interest rate of 0.85%. Moving forward, this will likely jump to around 5%, increasing interest payments on a billion-dollar tranche by six times. This increase will undoubtedly pressure Verizon’s future cash flows.

On the positive side, Verizon has some favorable debt, like a 40-year bond at an interest rate of 3.73% for $5 billion. In the context of expected long-term inflation at around 3%, this is almost like "free money." However, the overall picture is clear: Verizon’s stock is declining due to rising interest rates.

If interest rates reverse and the Federal Reserve cuts rates, it’s reasonable to expect Verizon’s dividend yield to drop back to 5%. All else being equal, this would lead to a 30-40% rise in the stock price.

Key Risks The primary risk for Verizon is a potential dividend cut, driven by narrower margins, slower-than-expected growth, or rising interest costs on its debt. If Verizon fails to manage its interest expenses, dividend payments, and free cash flow as effectively as it has in the past decade, a dividend cut could significantly damage the stock price.

Valuation

To assess Verizon’s intrinsic value, let’s examine the numbers. Currently, the dividend is $2.60 per share. The critical question is: how fast will Verizon grow its dividend in the future? Over the past two decades, the dividend has consistently grown. If this trend continues, Verizon appears fairly valued for a 10% annual return.

Using a 10% discount rate, the intrinsic value calculates to approximately $38.35, close to the current stock price. This indicates the stock is fairly priced for a 10% return.

If Verizon improves slightly or interest rates decrease, lowering the required dividend yield to 5%, the intrinsic value could rise to $50. In this scenario, investors could expect a 12-13% return.

In a pessimistic scenario, where there is no dividend growth and the yield rises to 8% due to higher rates, the present value sum would reflect a much higher risk-adjusted impact on the stock’s valuation.

Now, let’s consider the impact of a potential dividend cut. Suppose Verizon is forced to reduce its dividend in three years to manage its debt. If the dividend drops to $2 per share, the present value declines noticeably. If it falls further to $1.50, the present value could drop below $20. This highlights the key risk—a potential 50% decline in stock value if there’s no growth and a dividend cut. Even if dividend growth resumes later, the intrinsic value would remain low for a 10% return unless the stock price falls to around $20, offering a margin of safety.

For now, I’ll remove the dividend cut. Assuming all else is equal, Verizon appears fairly valued, even competitively priced compared to other options. However, the debt-to-equity ratio remains a significant concern, weighing down Verizon’s valuation.

In the value investing view, Verizon offers a 7% return potential with manageable risks tied to interest rates. It could be an attractive addition to a diversified portfolio, particularly for dividend-focused investors. Verizon’s consistent dividend and its essential role in communications infrastructure suggest long-term stability. Even if the stock price declines, reinvesting dividends allows you to accumulate more shares, potentially benefiting from future recovery.

The telecommunications sector, while competitive with ongoing pricing wars, isn’t likely to disappear. Verizon’s infrastructure investments, such as 5G, create a partial moat, though the high debt remains a constant burden. In a well-diversified portfolio, however, Verizon could be a solid addition, especially for those prioritizing dividend income.

Conclusion

Despite the challenges, Verizon plays a critical role in maintaining our communications infrastructure, and its dividend makes it worth considering for the right portfolio strategy.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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