Why Verizon's (VZ) Stock Price Jumped Too High Too Soon?

After a lukewarm first half of 2017, most of the major telecommunications stocks have done well in the third quarter. The momentum continues in the fourth quarter albeit at a slow pace. However, one particular company, Verizon Communications Inc. VZ, had a dream run on NYSE in the last three weeks. The company’s shares have surged 12.6% compared with a meager 1.7% gain for the benchmark S&P 500 Composite Market index.

We believe three-tier factors — macro-economic, industry-related and company-specific — have contributed to the bull run of Verizon. Here we will briefly discuss these.

Macro-economic Factors

(1)    The U.S. economy is on solid ground. Strong GDP growth supported by encouraging labor market, retail sales and industrial production data has accelerated economic activities. Consumer spending has increased, driven by encouraging economic conditions and strong government outlays. In the third quarter of 2017, the U.S. economy improved at an impressive annual rate of 3.3%. Moreover, business investment increased 3.9%, inventories rose 0.7% and the trade sector gained 0.4%.

(2)    The U.S. economy rebounded from the hurricanes and added 261,000 jobs in October 2017. Unemployment rate was 4.1%, the lowest since December 2000. Consumer confidence hit a new 17-year high in November 2017. This was also the fifth straight month of growing consumer confidence. The more the confidence households generate the more will they spend. Notably, consumer spending accounts for roughly 70% of the U.S. economy.

Industry-Related Factors

(1)    In the early hours of Dec 02, 2017, Senate Republicans passed a $1.5 trillion tax overhaul package proposed by President Donald Trump in a 51-49 voting. We believe that the U.S. telecom industry is going to be a major beneficiary of tax overhaul. The proposed reduction of corporate taxes from the current 35% to 20% will be a boon to telecom operators. Large carriers book major portion of their revenues in the homeland. Therefore, a significant reduction in corporate tax rate faced by telecom carriers would be immediately accretive to cash flow.

(2)    The telecom industry is highly capital-intensive in nature. Therefore, the immediate expensing of investment in all tangible, intangible and real property (other than land) would significantly benefit telecom carriers. This would encourage telecom operators to increase investment for capital expenditure.

(3)    Major proposals like a pledge to spend $1 trillion in infrastructure projects over a period of 10 years coupled with the above-mentioned policy changes are likely to spur higher consumer spending. This may create about 25 million new jobs over a decade, which in turn will fuel long-term economic growth.

(4)    A new Federal Communications Commission (FCC), headed by Ajit Pai, exercising lesser restrictions, certainly augurs well for the ISP (Internet Service Providers) industry. On Apr 3, 2017, Trump signed a repeal of the Obama-era broadband privacy rules. This has given a major boost to the ISPs. The digital advertisement market is growing exponentially and ISPs have been increasingly investing resources to cash in on bountiful opportunities.

(5)    More importantly, on Nov 21, Pai revealed a draft plan for a complete roll back of Net Neutrality. The FCC is set to vote on the proposed changes during its upcoming Dec. 14 monthly meeting. There is little doubt that if the new FCC scraps Net Neutrality laws, the ISP industry will be the major beneficiary. FCC’s attitude may also pave the way for new mergers and acquisition deals between ISPs and online digital media companies.

Company-Specific Factors

(1)    Verizon plans to launch next-generation 5G wireless residential broadband services in three to five U.S. markets in 2018. However, a full phased 5G wireless network will be offered only in 2020. The company is focusing on building a fiber and wireless infrastructure in a bid to deliver mobile video efficiently. The wireless giant, which was the first to deploy the 4G LTE (Long-Term Evolution) network nationwide, is initially testing equipment at 15GHz, 28GHz, 39GHz and 64GHz frequency bands for 5G network.

(2)    Accumulation of dark fiber will bolster Verizon’s cell network density consequently boosting its mobile backhaul network. The densification of cell network will help the company install and build its upcoming 5G network. Adoption of small cells has increased due to the inconvenience of installing large towers in inaccessible areas. Small cells will be used to augment its existing 4G LTE and upcoming 5G network and will primarily concentrate on high traffic locations like a business district or a shopping mall.

(3)    Upcoming 5G mobile networks will be of utmost importance in the management of exponential growth in Internet-of-Things (IoT). In other words, IoT has the potential of becoming the numero uno factor in driving growth in the space. Verizon is set to benefit from its diversification into the telematics segment 2018 onward. The U.S. telecom behemoth is an active player in the fleet management and telematics business through its Verizon Telematics subsidiary, which has operations in 40 countries.

(4)    Verizon has decided to take a massive $10 billion cost-cutting measure over a four-year period starting 2018. The company reiterates that it will witness year-over-year growth in services revenues in 2018 as more customers are expected to shift toward higher ARPU (average revenue per user) unlimited data plan. Most of its subscribers are on instalment plan, which will ensure lower promotional expenditure for devices.  

(5)    Verizon offers the most efficient wireless network in the United States. It has a strong portfolio of wireless spectrums of which a little more than half is currently used to support 4G LTE networks. The telecom behemoth is continuously investing in its wireless and wireline fiber-optic networks.

(6)    Verizon is planning to merge its video streaming service, Go 90, into its digital platform Oath. Verizon pre-estimates to have 1.3 billion users and $7--$10 billion of revenue growth, by 2020, from the combined AOL and Yahoo. Management has chalked out plans of increasing Oath's combined user base from 1.3 billion to 2 billion and achieve revenue growth in the range of $10--$20 billion by 2020.

Near-Term Concerns

(1)    The U.S. telecom market continues to witness intense pricing competition, as success to a great extent depends on technical superiority, quality of services and scalability. Moreover, the U.S. wireless industry is likely to become competitive in 2018 with the entry of cable MSOs (multi service operators) in this space. In order to stay abreast of competition, existing players need to be constantly on their toes and introduce innovative products to gain from the industry’s growing momentum.

(2)    Technological upgrades and breakthroughs have resulted in cutthroat price competition. Product life-cycle and upgrade-cycle have been reduced drastically as several firms are coming up with new products and services in no time. Increasing competition is compelling players to offer heterogeneous and bundled services to retain their position in the space.

While Verizon offers several growth catalysts in the long-term buoyed by favourable economic and industry-related factors as well as its own technological superiorities, we believe investor’s should also take care of any near-term fluctuations in stock price due to growing competition and increasing saturation of the U.S. wireless market.

Verizon competes intensely with AT&T Inc. T, T-Mobile US Inc. TMUS and Sprint Corp. S. We believe that these are the primary reasons behind the stock currently carrying a Zacks Rank #3 (Hold).  You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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