Verizon (VZ): A High Yield Dividend Stock Owned by Warren Buffett

Verizon (VZ) is one of Warren Buffett’s high-yield dividend stocks. The company has paid dividends for more than 30 years and has increased its dividend for over 10 straight years.

 

Paying uninterrupted dividends for as long as Verizon has is usually the sign of a durable company.

 

Verizon is a blue-chip dividend stock that enjoys high barriers to entry in its core markets and has made a number of strategic investments to prepare itself for the technological changes impacting the communications industry.

 

With a high dividend yield in excess of 4% and a very safe dividend payment, Verizon is a company I like in our Conservative Retirees dividend portfolio.

 

Business Overview

Verizon is the largest wireless service provider in the United States. The company’s 4G LTE network is available to over 98% of the country’s population.

 

Wireless operations generated close to 70% of Verizon’s revenue last year and accounted for over 90% of the company’s operating income.

 

Wireline operations accounted for just less than 30% of the company’s revenue in 2015 but only generated about 7% of Verizon’s operating income. This segment includes broadband video and data and traditional voice services.

 

Overall, Verizon maintains more than 112 million wireless retail connections, 7 million Fios internet subscribers, and 5.8 million Fios video subscribers.

 

Business Analysis

Verizon’s key to success has been delivering reliable wireless and wireline services over the best communications network in the country.

 

During 2015, Verizon invested roughly $28 billion in capital and spectrum licenses to increase the future capacity of its wireless network and enhance its fiber network.

 

The company’s investments have kept it at the top of Root Metrics’ rankings of wireless reliability, speed, and network performance for each of the last five years. The chart below shows overall performance metrics for the big four carriers:

 

Source: Root Metrics

 

Verizon’s 4G LTE network is available to over 98% of the U.S. population and covers roughly 312 million people.

 

With about 90% of wireless data traffic now riding on the 4G LTE network, Verizon has already begun work to get its network ready for 5G wireless technology.

 

The company expects to conduct trials of 5G during 2016 and begin commercial deployment thereafter.

 

Verizon has historically enjoyed a two-year advantage on its competitors when moving to the next generation network architecture, and the company seems to be doing everything it can to make sure this remains the case with 5G.

 

Further helping its competitive positioning, Verizon maintains one of the 25 most valuable brands in the world. Consumers and businesses trust Verizon’s network reliability and superior performance.

 

As long as Verizon continues to invest in its leading network coverage and architecture, the company should continue maintaining a massive base of customers.

 

Disrupting Verizon’s base of customers would be almost impossible barring a revolutionary change in network technologies.

 

Growth in the number of new wireless subscribers has slowed considerably with smartphone adoption now being widespread.

 

With new customer growth hard to come by, the industry has consolidated to become more productive and expand coverage. Verizon, AT&T, T-Mobile, and Sprint generate almost all of the industry’s revenue today.

 

Verizon’s large subscriber base provides it with the cash flow needed to support and enhance its existing wireless network. Potential new entrants lack the subscribers needed to fund a nationwide wireless network and acquire spectrum licenses, effectively keeping them locked out of the market.

 

Trying to win subscribers over from Verizon would be extremely costly and impractical. It’s a lot easier to maintain an existing large base of subscribers in a mature market than it is to build a new base from scratch.

 

While competition between the four major carriers is intense, Verizon’s scale and leading market position has enabled its wireless segment to deliver excellent EBITDA margins in excess of 40% and predictable earnings.

 

Simply put, new entrants lack the capital, spectrum, and subscriber base to effectively compete with any of the big four carriers in the U.S.

 

In addition to the industry’s high barriers to entry, the wireless communications market is also appealing because its services are non-discretionary in nature.

 

For example, Verizon’s churn rate (i.e. the percentage of customers who leave) in its wireless business was about 1% last year. The majority of the company’s revenue is also recurring because consumers and businesses have a continuous need to communicate and use data.

 

As mobile and broadband usage continues growing with increased consumption of data and video, Verizon’s wireless network will become increasingly valuable – or at least that is what the company is banking on as it gradually exits wireline businesses and doubled down on wireless two years ago.

 

Verizon sold off around a quarter of its wireline phone and internet operations for $10.5 billion in 2015, reducing its exposure to these slower-growing businesses that face increased regulatory scrutiny (e.g. regulate internet lines as a utility).

 

This move is part of Verizon’s ongoing shift to concentrate its efforts on its wireless business, which is more profitable with better growth prospects.

 

Verizon doubled down on wireless with its $130 billion acquisition of Vodafone’s 45% interest in Verizon Wireless in February 2014.

 

With full control over Verizon Wireless, the company continues to aggressively invest in its industry-leading network as it prepares for the continued surge in data consumption.

 

However, Verizon is also developing new business models focused on video, the Internet of Things, and content. Rather than rely completely on its network infrastructure, Verizon is positioning itself to benefit from the rise in mobile advertising and connected applications.

 

Verizon acquired AOL for $4.4 billion in June 2015 to gain a mobile advertising platform and online content such as The Huffington Post and TechCrunch.

 

Verizon is now on the hunt to acquire Yahoo, which would give it ownership of the third and sixth most-popular web properties in the U.S.

 

Verizon presumably has plenty of data surrounding its customers’ mobile behaviors, which could give it a chance of challenging Google and Facebook in the mobile advertising market.

 

The company also recently launched go90, a free mobile TV platform that delivers content for millennials that has been described as Hulu meets Twitter. Verizon has reached content deals with the NFL, NBA, Vice Media, and major advertisers who want to reach this demographic.

 

These initiatives could help lower churn, further strengthen the Verizon brand, and generate advertising revenue as they continue to scale.

 

Internet of Things is another growth area for Verizon and brought in $690 million in revenue in 2015, up 18% from 2014. Telematics, smart energy, lighting, agricultural technology, and more are driving demand in this area.

 

Despite the excitement around these initiatives, they won’t be moving the needle for Verizon anytime soon. For example, Internet of Things revenue accounted for less than 1% of Verizon’s total sales last year.

 

Management has also stated that a significant revenue stream from these new business models is likely two to three years out.

 

Verizon’s investments in these areas underscore the evolution that is occurring in the telecom industry, driven in part by changing consumer preferences.

 

However, the company’s moat remains strong in my view. Verizon will be a critical player serving the communications needs of millions of consumer and businesses alike for many years to come.

 

Key Risks

The biggest uncertainty facing Verizon is future growth in wireless. Subscriber growth has largely plateaued as smartphone penetration has already tripled since 2010.

 

Sprint and T-Mobile have also improved the coverage and quality of their networks while becoming more aggressive with their pricing plans, somewhat narrowing the network quality advantages enjoyed by Verizon.

 

It’s hard to say what will drive the next wave of wireless growth. Internet of Things, video, and virtual reality are all candidates, but it’s difficult to forecast when they could start moving the needle.

 

If growth in the wireless market weakens, the battle between incumbents for existing subscribers could intensify and pressure the industry’s margins.

 

Not surprisingly, Verizon has been on the hunt for new areas of growth. Content and mobile advertising are two areas the company has made a big push into.

 

While Verizon is certainly not betting the house on these markets, they still present some strategic and financial risk given the company’s lack of expertise in these areas.

 

Looking even longer term, some investors have expressed concern about WiFi’s potential to disrupt Verizon’s business. As WiFi coverage continues expanding, perhaps it could eventually pose as a viable alternative for some existing wireless customers.

 

While I am far from a technology expert, I don’t believe this risk is likely. WiFi has limited capacity, slower speeds, and needs a relatively clear line of site between the network and WiFi user. There are plenty of coverage gaps as well.

 

Overall, I expect Verizon to continue generating predictable results for many years to come. The telecom industry is slowly evolving and the wireless market is in need of new growth drivers, but the industry’s high barriers to entry, oligopoly status, and non-discretionary services should not be ignored.

 

Dividend Analysis: Verizon

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Verizon’s dividend and fundamental data charts can all be seen by clicking here.

 

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Verizon’s Dividend Safety Score of 89 suggests that the company’s dividend is very safe. Verizon’s dividend is first supported by the company’s healthy payout ratios.

 

Over the last four quarters, Verizon’s dividend payments have consumed approximately 50% of the free cash flow and earnings the company has generated.

 

As seen below, Verizon’s payout ratios have generally remained between 40% and 60% most years. A stable payout ratio usually indicates that a company’s dividend growth (if any) has been driven by underlying growth in earnings and free cash flow. Consistent payout ratios are often the sign of a stable business as well, and Verizon is no exception.

 

 

One way I like to gauge business stability is by evaluating a company’s performance during the last recession. Companies that saw major declines in sales and earnings could be more vulnerable to future dividend cuts.

 

As seen below, Verizon delivered excellent performance during the last recession. The company’s sales were down just 1% in fiscal year 2010, and its free cash flow per share actually increased each year. Verizon’s stock also outperformed the S&P 500 by nearly 20% in 2008.

 

Businesses and consumers need Verizon’s wireless services regardless of how the economy is doing, and the company certainly benefited from the rise of smartphones during this time as well.

 

 

Free cash flow generation is another key factor impacting dividend safety. Companies that fail to generate free cash flow cannot sustainably pay dividends unless they issue debt or equity. I only invest in businesses that consistently throw off cash.

 

Verizon has generated positive free cash flow in each of its last 11 fiscal years. The company’s huge subscriber base provides reliable cash each year that more than covers the capital spending needed to maintain and enhance Verizon’s wireless network.

 

 

A company’s return on invested capital is one of the most important financial ratios for dividend investing because it provides clues about a company’s economic moat and ability to quickly compound earnings.

 

Businesses that earn high and steady returns on invested capital create economic value and often have a stronger ability to pay steady, growing dividends.

 

Verizon’s business requires a lot of capital, which keeps a lid on the returns it can earn. However, as seen below, Verizon has generated steady returns in the high-single digits most years. This rate of return is about average, but the company’s consistency highlights the predictable nature of its operations.

 

 

The biggest factor weighing on Verizon’s Dividend Safety Score is its debt burden. The company took on substantial debt when it acquired Vodafone’s interest in Verizon Wireless in 2014.

 

Verizon has an objective of reducing its debt to return to its pre-Vodafone transaction credit rating profile in the 2018-2019 time frame.

 

As seen below, Verizon has close to $6 billion in cash on hand compared to total book debt obligations of $110 billion. The company will rely on continued free cash flow generation ($21 billion last fiscal year) and potentially the sale of more wireline assets to continue restoring its balance sheet.

 

Each of the major credit agencies has issued a “stable” outlook for the company, and I am not overly concerned about Verizon’s financial leverage given the predictable cash flow it generates.

 

The substantial majority of Verizon’s debt also has fixed interest rates, so changes in interest rates won’t have a material effect on the company’s interest payments.

 

 

Overall, Verizon’s dividend looks very safe to me. The company maintains healthy payout ratios, consistently generates free cash flow, provides non-discretionary services, and has demonstrated a commitment to paying and growing its dividend.

 

While Verizon’s balance sheet could be in better shape, the company’s cash flow and selective sales of wireline assets should help it recover over the next few years. The balance sheet should not impair Verizon’s ability to continue making dividend payments.

 

Dividend Growth Score

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Verizon’s Dividend Growth Score is 43, which indicates that the company’s dividend growth potential is somewhat below average.

 

Verizon stock began trading in July 2000. Prior to this date, Verizon’s stock was trading as Bell Atlantic. Verizon has increased its dividend for 10 consecutive calendar years and is a member of the Dividend Achievers Index.

 

If Bell Atlantic’s dividend history is included, the company has paid uninterrupted dividends since 1984 and increased its dividend all but seven years since then.

 

While Verizon’s dividend has been consistent, growth has been low. Verizon’s dividend increase in 2015 was 2.7%, and the company’s dividend has grown by 4.4% per year over the last decade.

 

 

Looking ahead, dividend growth will likely remain between 2% and 3% per year, tracking Verizon’s underlying business.

 

The company could temporarily increase its dividend growth rate to raise its payout ratio, which sits near 50% compared to AT&T’s payout ratio near 70%. However, paying down debt is a greater priority over the next few years.

 

Valuation

Verizon’s shares trade at a forward-looking P/E ratio of 14.1 and offer a dividend yield of 4.1%, which is lower than the stock’s five-year average dividend yield of 4.7%.

 

In my view, Verizon will continue to grow its earnings per share at a low-single digit rate over the coming years. Demand for wireless services should roughly track GDP growth, and it’s hard to move the needle much faster for a company with more than $130 billion in annual sales.

 

Under this assumption, Verizon’s stock appears to offer annual total return potential of 6-8% (4.1% dividend yield plus 2-4% annual earnings growth) over the long term.

 

However, today might not be the best time to initiate a new position in the company. Verizon’s stock has returned nearly 30% over the last six months, more than doubling the S&P 500’s return.

 

Safe havens with high yields such have been bid up as global growth remains subdued and interest rates continue to fall. Verizon’s stock has certainly benefited from this development.

 

Given the company’s current valuation, I would prefer to wait for Verizon’s dividend yield to cross back over 4.5% before allocating additional funds to the stock.

 

Conclusion

Verizon is one of the most reliable dividend stocks in the market. While the telecom industry is evolving, Verizon’s scale, hard-to-replicate assets, mission-critical services, brand recognition, and massive subscriber base are all here to stay.

 

The company’s dividend continues to look very safe despite Verizon’s high debt load, and I expect safety to further improve as management reduces debt over the coming years.

 

While the stock doesn’t look particularly cheap after its strong run over the last six months, I believe Verizon remains a reasonable hold for long term dividend investors. Conservative investors living off dividends in retirement should especially keep a close eye on the company.