Verizon stock (NYSE:VZ) have been brutalized following last week’s gains, which I believe creates a buying opportunity for the telecom company. Verizon slipped 7% on Friday after the company reduced and disclosed its earnings guidance for fiscal 2022 that it expected slower growth due to price pressures and inflation. Despite weaker free cash flow expectations, I believe Verizon’s risk profile is extremely benign right now. Since the company covers its dividend with FCF, I don’t expect Verizon to lower its dividend payments!
Parallels to AT&T, lower free cash flow expectations
AT&T (T) shares also slid last week after the telecom company cut its year-to-date free cash flow outlook to $14 billion from $16 billion as customers took longer to pay their bills. Despite the $2 billion decrease in free cash flow forecast compared to the previous outlook, AT&T’s rising yield and low FCF valuation factor made AT&T a buy. I explained last week’s events in AT&T: Be Greedy When Others Are Fearful.
Verizon’s Q2’22 earnings chart produced a similar outcome to AT&T’s: the stock bottomed out.
Verizon’s earnings showed a small EPS loss, but its lowered fiscal 2022 earnings outlook has sparked a big price drop.
While the US wireless carrier trimmed its revenue and revised its fiscal 2022 EPS guidance, the company didn’t provide a specific free cash flow guidance. What Verizon gave, however, was a forecast for its revenue growth. Verizon’s previous guidance called for 9-10% revenue growth for wireless services, which has been downgraded to 8.5-9.5%. Services and other revenue growth is now expected to be slightly negative, (1)% – flat year-on-year compared to a previous flat forecast. Verizon’s adjusted EPS guidance was downgraded 5.5% to a new range of $5.10 to $5.25 due to pricing concerns and inflation hurting the business.
While Verizon hasn’t provided an estimate of fiscal 2022 free cash flow, we can calculate an estimate based on the downgrade of AT&T’s FCF outlook for fiscal 2022. AT&T cut its free cash flow by $2 billion, or 12.5%, from its year-over-year outlook.
I recently estimated that Verizon has about $22 billion in free cash flow, with FCF set to increase with Verizon’s 5G rollout. If we were to apply a (safer) 15-20% discount to that free cash flow estimate — to account for Verizon’s growing revenue and FCF risks — the US wireless carrier could return between 17.6 and 18.7 Billions of dollars in free cash see flow in FY2022.
Verizon had free cash flow of $7.2 billion in the first six months of the year. So the joker will be how much free cash flow the telecom company can secure in the second half of the year.
If we were very cautious and assumed that Verizon could only double its free cash flow to $15 billion in the first half of 2022, Verizon would be doing a good deal: Based on a low-case estimate of $15 billion in FCF Verizon would have a FY 2022 P-FCF ratio of 12.4X. Due to last week’s decline, Verizon’s stock is now yielding 5.76%.
Is the dividend at risk?
In theory, as free cash flow risk increases, so does dividend risk. Since Verizon’s business still generates a tremendous amount of free cash flow annually, I don’t see the company cutting its payout, and a quick calculation supports this: Verizon has 4.2 billion shares outstanding and pays an annual dividend of 2 $.56, which means the cost of paying dividends to Verizon is about $10.8 billion per year …that’s about 72% of the estimated FCF estimate I derived for fiscal 2022.
Risks at Verizon
Verizon’s free cash flow risks have risen slightly, but not to the extent that investors need to worry about the dividend. Even with lower projected free cash flow this year, Verizon should be able to cover its dividend payments without any major problems. What I see as greater commercial risks for Verizon over the longer term are slower revenue growth and lower margins in the fast-growing 5G market.
The market went insane last week and I think it totally overreacted to the earnings releases and forecasts from both AT&T and Verizon. Both telecom companies were trampled when valuations plunged more than 10% last week. The downgraded guidance is only a short-term concern for Verizon, in my view, and the decline creates a buying opportunity: with a yield of 5.8% and a robust amount of free cash flow to generate this year despite economic headwinds, I believe the Share has become more interesting, not less!