Verizon Invokes The AI Warhead

Summary:

• Verizon Communications Inc. reported mixed Q1 earnings, with revenues below expectations but strong customer additions and cost controls.
• The company is embracing AI and has new partnerships with the NFL and NHL.
• Despite the debt burden, the dividend is well covered and Verizon is on track for strong free cash flow this year.
• Consider option income here.

Verizon Communications Inc. (NYSE:VZ) is a stock we traded quite a bit in 2023. In our trade for our investing group, we added the stock with buys at $34 and $31 back to $40. While our traders took profit at our service, many of them kept a portion of the profit in a so-called “house position,” allowing them to collect long-term future gains, all dividends, spinoffs, etc. It is one of our favorite approaches for wealth creation long term that we like to employ after successful rapid-return trades.

Since then, the stock has been mostly sideways, which is just fine by us for an income name. Today, we revisit the name as Verizon just reported its Q1 earnings. Overall, it was a mixed bag, with some positive points and some negative. We still like this as a stock for long-term income and/or compounding in a tax-favored account as well. We reiterate our Buy rating, and are most notably drawn to the fact that Verizon had its best quarter for consumer postpaid accounts since 2018, had its best business FWA on record in the quarter, and is embracing and calling out AI in its earnings messaging. Let us discuss.

Verizon Q4 results in context

This is a key earnings season. Markets are finally in a correction. The market has reset expectations for a Fed rate cut. There are international macro concerns weighing. All of this is combined to create a powder keg for stocks that finally sent the S&P 500 (SP500) below its 50-day key technical moving average. And for Verizon, a stock that has been moving sideways, the results give us color into the future path for the investment.

That said, Verizon’s revenues were below expectations. While we thought Verizon may once again have difficulty with margins and earnings from being very promotional to attract customers, the earnings power was strong considering a revenue figure that missed expectations by $230 million. Revenue came in at $33.0 billion and rose 0.3% from last year. See the infographic below:

The comps of interest of most importance are largely summarized above for Q1. What about the revenue drivers?

Verizon’s Q1 2024 earnings revenue drivers

As we saw, revenues were up 0.3% but below expectations. For Q1, we were looking for $33.2-$33.4 billion for the top line, so these results were also below our projections. Please remember that we were slightly more bullish than consensus. Our expectations were missed by $300 million. What about customer additions? We were looking for retail postpaid net additions of 225,000+ and wireless postpaid phone gross additions to increase in low-single digits year-over-year. We were also looking for churn below 1.2% for retail postpaid customers. For broadband, we were looking for net additions of 400,000 and were projecting 45,000+ Fios Internet net additions.

In wireless, there were actually postpaid phone losses of 68,000 and retail postpaid net adds of 253,000, the latter exceeding our expectations, though the Q1 phone losses are not necessarily surprising. Q1 also brings a lot of churn. For postpaid, churn came in right around what we were looking for at 1.15% overall. Consumer wireless retail postpaid churn was 1.03%, and wireless retail postpaid phone churn was 0.83%. Business wireless retail postpaid churn was 1.15%, and wireless retail postpaid phone churn was 1.13%.

Over in broadband, there were net additions of 389,000. Once again here in Q1 2024, we saw continued robust demand for fixed wireless and Fios products, though this missed our expectations slightly. There were 354,000 fixed wireless net additions.

This was the first quarter of the last 6, however, to fail to add more than 400,000 broadband net additions. We do not see this as bearish, the growth remains strong and there are well over 3 million subscribers. There were 53,000 Fios Internet net additions, also surpassing our expectations of 45,000. Overall, it was a good but mixed quarter.

Verizon Q1 2024 earnings outperformance

For Q1, we were expecting ongoing cost controls to continue to play a part in the story, and to help accelerate this process, Verizon is turning to AI. Verizon is enabling AI at scale and will be using it to improve the overall business and customer service. There were also exciting new partnerships with the NFL and NHL. Q1 2024 operating expenses were $25.46 billion while we were targeting operating expenses of $25.5-$28.6 billion, so this was slightly better than expected, and about flat from last year’s operating expenses. We were targeting an operating income of $7.5-$7.6 billion. These expectations were about spot on at $7.52 billion in operating income, though this did slip 0.8% from a year ago.

For adjusted EBITDA, we are targeting $11.8-$12.0 billion. On a per-share basis, assuming our projections capture the results with relative precision, we saw EPS of $1.10-$1.15 for Q1. Analysts were looking for $1.12, in the lower half of our target range. Well, despite the top-line miss, with well-controlled operating expenses, the company reported $1.15 in EPS, exceeding consensus and hitting the top range of our expectations. Adjusted EBITDA was $12.1 billion, also edging out our expectations slightly.

Verizon’s free cash flow is not in danger, Q1 is always light

Assuming cash from operating activities of $7.4 billion-$8.1 billion, capex and other expenditures of $4.3-$4.7 billion, we were targeting free cash flow of $2.7 billion to as high as $4.8 billion. Well, cash flow from operations was $7.1 billion, and there was a large $2.5 billion change in current assets and liabilities which did not jibe with our expectations. Capex was $4.6 billion. Keep in mind that Verizon pays more each year to the dividend. Dividends paid were about $2.75 billion in Q4. Free cash flow was $2.7 billion, at the lowest end of our free cash flow expectation. As such, the free cash flow payout ratio was just over 100% here.

Now fear not, this is very common for Q1 to have low overage if not negative coverage. For the year, we are anticipating a payout ratio of less than 75%.

Verizon stock risk is the debt

We say this every time we cover the stock, but it needs to be reiterated. Look, the debt will never, ever be paid off. There will be constant new refinancing or issuing of debt to fund constructions, research, spectrum auctions, to build out and leverage AI, etc. But leverage will be reduced, taking less and less of cash flows. The debt burden is large, make no mistake. Interest expense will continue to climb on new debt at higher rates in this climate. So, the company is trying to chip away at the debt. The net debt dipped slightly to $126.0 billion, down $3 billion from a year ago, and the net debt-to-adjusted EBITDA ratio ticked down from 2.7X to 2.6X.

Final thoughts

For income seekers, the dividend is well covered, do not let Q1’s shortfall lead you astray. Verizon is on track for about $19 billion in free cash flow this year. Changes to this outlook could hit the stock, however. Free cash flow and debt needs to be watched, but the latter is coming down. We still expect to see growth of 2-3.5% in total wireless service revenue, total revenue growth of flat to up 2%, adjusted EBITDA growth of 1-3%, and adjusted EPS of $4.50-$4.70. Capex has been guided to be $1.0-$1.5 billion lower. Better days are ahead.

Have something to share?

Do you think the company’s future is looking shaky? Can they overcome their debt burden? Are you a long-term investor, holding on to the stock for dividends? Do you trade options for this company’s stock? What’s your strategy for maximizing gains? Know of any other dividend-paying stocks that are strong contenders? Anything else to add to the discussion?

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of VZ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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