Sell Verizon (VZ)

09/20/2011 1:42 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

This iPhone thing just isn’t working out—for Verizon (VZ) that is.

The thought on Wall Street was that the company’s addition of Apple’s iPhone to its lineup of smart phones would drive Verizon’s smart phone market share higher and increase the all-important ARPU (average revenue per user) number.

But it just isn’t happening. At least not to the degree that Wall Street expected.

Maybe you could pass off the first quarter disappointment on these numbers as birthing pains for Verizon’s new offerings but the second quarter numbers came in much the same. I think we’ve got a trend here and it’s not one that investors in the stock should be happy with. The shares are up 6.71% for 2011 to date and 23.07% for one-year. Both of those numbers are ahead of the gains for the Standard & Poor’s 500 Index. Despite the 5.4% dividend on the stock, I’d take my gains here and look for a better total return play. (Verizon is a member of my Dividend Income portfolio http://jubakam.com/portfolios/ )

For the second quarter, reported on July 22, Verizon did add wireless subscribers to the tune of 1.23 million. Which would have resulted in really great news for the company’s revenue and profit lines except that the new and old users didn’t show much inclination to spend more on their monthly wireless bill by increasing their use of data services. ARPU grew by just 1.9% to $46.62 in the quarter and that was 6.5% below the Wall Street consensus on that measure. Verizon did increase its smart phone penetration among its customers by about 4 percentage points but the company’s smart phone sales as a percentage of sales (60%) continued to lag that of AT&T (70%).

I think this is an issue for a couple of reasons.

First, return on invested capital. Verizon is engaged in an extremely expensive capital spending program to build out its wireless and optical fiber FIOS systems. Capital spending came in at $2.7 billion for the quarter, 11% above the Wall Street consensus of $2.4 billion for the quarter. When you’re spending that much money, it matters how much extra revenue that investment is bringing in. FIOS is still a very small part of Verizon’s total revenue stream. It would be helpful if the wireless build out—and the smart phones that are at the core of the profitability of that build out—were kicking in more and not less than expected.

Second, valuation. Right now Verizon shares are trading at a price-to-earnings premium to those of AT&T (T), 16.6 times trailing 12-month earnings to 13.4. That’s understandable given the uncertainty surrounding AT&T’s acquisition of T-Mobil. But if you’re purely an income investor that uncertainty gives AT&T a yield advantage 6% to 5.4% over Verizon. And if you’re a total return investor the higher price-to-earnings ratio and the disappointment with ARPU suggest looking elsewhere.

Full disclosure: I don’t own shares or units of any of the companies or partnerships mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post.  The fund did not own shares of AT&T or Verizon as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

 

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