Earlier today we added the shares of Verizon Communications (VZ) to the portfolio with a One rating and a $60 price target. Like McCormick & Co. (MKC) and PepsiCo (PEP) , Verizon has a defensive business model, especially in today's always on, always connected society, and a history of increasing its annual dividend.
The current annualized dividend sits at $2.58 per share, offering roughly a 5.1% dividend yield based on the current share price. The stickiness of that business model along with price increases for its wireless business bode rather well not only for upward EPS revisions for the coming quarters, but also the high probability Verizon continues to increase its dividend once again.
Consumer and Business
As many likely know the company offers wireless and broadband services to both consumers and businesses but reports its financials in two buckets - Consumer and Business.
The Consumer business, which includes wireless equipment and services as well as residential fixed connectivity solutions, including internet, video, and voice services, is ~75% of Verizon's revenue stream but ~90% of its operating income. Exiting the March 2022 quarter, the company had 115.2 million wireless customers split between 91.4 million pre-paid and 23.8 million postpaid, and 7.1 million broadband consumers, the vast majority of which are Fios Internet customers.
From a revenue and operating profit contribution perspective, the Business segment accounts for ~25% and 10%, respectively. Through this segment Verizon offers wireless and wireline communications services and products, including data, video and conferencing services, corporate networking solutions, security and managed network services, local and long-distance voice services, and network access to deliver various Internet of Things (IoT) services and products.
To be blunt, while the Business segment has little changed over the last few years, given its size relative to the overall revenue and profit stream, it's the Consumer business we're inclined to focus on most. Also, Verizon has no significant international operating revenue per its filings with the SEC, which means its foreign exchange risk is negligible.
What's attracting us to Verizon, in addition to its pension for consistently increasing its dividend over the last 15 years, is the increasingly inelastic nature of its wireless business, particularly with consumers. As many if not all of us realize, these connected devices are a need to have expense especially as many consumers have cut the chord over the last several years, a move that increasingly has eliminated land line service.
When one thinks of goods and services with inelastic demand the cut to the quick responses are utilities, like American Water Works (AWK) , prescription drugs, and tobacco products, because the degree in the change in demand when there is a change in another economic factor, such as price or income, is low. We would argue the same is largely true with wireless service in our increasingly connected world and digital society
With mobile phone penetration in the U.S. topping more than 80%, demonstrative share gains are likely to be limited against key competitors AT&T (T) and T-Mobile (TMUS) . The coming years will see opportunities as the number of connected devices per person continues to grow thanks to the IoT market that ranges from smart watches to the smart home and industrial applications. In the meantime, the leverage point for Verizon's revenue stream is likely to be its ability to pass through pricing given that inelastic nature of its business.
On May 16, Verizon announced that effective June 23 (today) it will be increasing the monthly administrative fees per voice line by $1.35, going from $1.95 a month to $3.30. If you have a smartwatch, tablet, or laptop that can make a phone call, you will also see the same increase there, but hotspots won't be impacted.
We have to point out that increase is per line per month, which means a family of five smartphones will see their bill increase by just over $80 per year. Businesses with lines that meet certain criteria will see the "Economic Adjustment Charge" on their monthly bill starting June 16. Charge amounts will be $2.20 per line for each smartphone or data device, and for basic phone and tablet devices, the charge will be 98 cents per line.
The implementation of those prices increases bolsters in our view the consensus forecast that calls for Verizon's revenue to rise 3.9% in the second half of 2022 to $69.7 billion vs. $67 billion in the first half of the year. Given the timing of those increases, the company should see continued flow through to its revenue in the first half of 2023 as well. Interestingly enough, we have yet to see any lift in the consensus EPS forecast for this year or 2023 over the last 60 days, which means these prices increases and their impact have yet to be baked into expectations.
During the shoot first, ask questions later during the pandemic, VZ shares bottomed out at near $50.30, not too far from where the shares are now. Over the last few years, VZ shares have peaked between 12.6x-12.9x forward earnings, which would imply a target price of $70-$72. We'd point out those targets are on current consensus expectations, the ones that haven't been adjusted for the rate hike coming for Verizon wireless business. Even so, a respectable discount to that peak P/E range still offers ample upside to $60 and when we add back the current dividend yield of 5%, we have a total return opportunity of roughly 23%.
Like most new positions that come into the portfolio, we are starting off relatively small but will look to build out the position size in the coming days and weeks.