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Verizon - Falling equipment sales hit revenues

Nicholas Hyett, Equity Analyst | 24 April 2020 | A A A
Verizon - Falling equipment sales hit revenues

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Verizon Communications Inc Com Stk US0.10

Sell: 57.15 | Buy: 57.21 | Change 1.66 (2.98%)
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Verizon's first quarter operating revenue fell 1.6% to $31.6bn. The group reported $1.26 in adjusted earnings-per-share (EPS), up from $1.20 in the same period last year.

Management thinks COVID-19 has reduced EPS by around 4 cents, mainly because of an increase in bad debts.

The shares were broadly flat following in early trading.

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Our view

Verizon is one of the world's largest telecommunications groups. Operations are focused on the US, but there's a wide UK shareholder base, after it bought Vodafone out of a joint venture with a shares-plus cash deal in 2014.

Verizon has recently restructured itself into three segments. The two main operating segments are Consumer and Business, with Corporate and Other picking up what's left over.

Consumer is by far the larger of the two primary segments, accounting for over two thirds of group revenue. It provides wireless and landline services directly to individuals and via wholesalers. It also sells tech such as smartphones and laptops. The Business segment generates just under a quarter of revenue and provides similar services to companies and government organisations.

More broadband connections, and increasing demand for smartphones, have so far provided a favourable backdrop to the group. However, lockdowns and social distancing have made it harder to sell new equipment, and if we enter a prolonged recession demand may be reduced for some time. However, longer term the roll-out of 5G could end up being the "secret sauce" that helps the Internet of Things and other applications live up to their potential.

Falling debts mean the balance sheet is in good shape, and earnings and cash flows both look reasonable to us. The group's managed to find $6.3bn of cumulative savings since a $10bn plan was announced in 2018. That's helped support the dividend, and the shares offer a prospective yield of 4.4%.

However, it's no one way ticket.

The landline operations aim to surf the wave of higher speed internet, but established internet and landline services are in decline. This is already pushing the operations to a loss, and significant business-to-business sales mean fortunes are closely tied to those of the US economy. Mobile is a more reliable end market, but it's notoriously competitive.

What's more, with governments finding ways to squeeze more out of spectrum auctions, we wouldn't be surprised to see it having to fork out significant sums on 5G in the not-so distant future. That would be on top of the everyday maintenance of its sprawling asset base. Capital expenditure has averaged $17bn over the last 3 financial years, and is set to increase.

For now Verizon looks in reasonable financial shape, and the potential to provide the infrastructure behind a new age of connectivity is a clear attraction. But investors shouldn't forget it'll come with lofty demands on cash that would otherwise be finding its way back to shareholders.

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First Quarter Results

Total revenue declined primarily because social distancing measures limited equipment sales, more than offsetting a rise in Consumer and Business wireless service revenue.

The Consumer segment revenue fell 1.7% to $21.8bn, of this $13.5bn was wireless service revenue, a 0.9% increase compared to last year. In response to COVID-19 Verizon closed 70% of its retail stores, significantly impacting customer activity, with a 525,000 fall in post-paid wireless customers. Operating income increased 0.4% to $7.3bn.

The smaller Business segment saw revenues fall 0.5% to $7.7bn, despite an increase in demand for products and services needed to facilitate working from home. The segment reported a net 475,000 wireless post-paid additions, compared to 264,000 last year. Segment operating income was $954m, down 9.0% on last year.

Group wide operating cash flow reached $8.8bn in the quarter, a $1.7bn increase on the same period last year as one off pension and voluntary redundancy related payments weren't repeated.

Capital expenditure was $5.3bn and the group ended the quarter with $7bn in cash on hand, up from $4.5bn at the end of 2019. This increase includes the proceeds of a $3.5bn bond sale completed in March.

Management now expects adjusted EPS growth between -2% and 2%, down from 2% to 4%.

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