4 Reasons to Buy the Big Red Machine

Sometimes chasing a high-yield makes sense, but in this case investors should just buy the strongest company and be thankful for the better than 4% yield that comes with it.

Feb 2, 2014 at 9:00AM

If you are looking for a superior yield, it's hard to ignore the telecommunications sector. That being said, investors need to look beyond yield and to make sure they buy the company that offers the best overall value. Though Verizon Communications (NYSE:VZ) offers a lower yield than its peers, there are at least four reasons to believe that Big Red will continue to trounce the competition going forward.

Almost whole and a whole lot better
Verizon expects to close its acquisition of the remaining 45% of Verizon Wireless by the end of February. In connection to this acquisition, the company expects this deal to be immediately accretive to earnings by 10%.

While AT&T (NYSE:T) and many other companies are battling every day to grow their wireless business, Verizon Wireless is outperforming its peers at every turn. The company's strength in its wireless division is just one of the reasons to bet on the Big Red Machine. On the simplest measure of performance, Verizon Wireless posted 5.7% revenue growth compared to a 4.5% increase at AT&T's wireless division. Top-line growth is just the start of how Verizon Wireless bests its chief rival:

Company

Wireless Op. Margin

Postpaid ARPU (avg. revenue per user)

Postpaid Churn

AT&T

21.4%

2.1%

1.11%

Verizon

29.5%

7.1%

0.96%

Source: SEC Filings

Based on some of the most important metrics, Verizon Wireless is outperforming AT&T. Given that each company's wireless division carries higher margins and profits than their respective wireline businesses, the advantage lies clearly with Verizon.

Growing faster in this industry as well
One of the key growth drivers for many local telecommunications companies is their high-speed Internet business. While companies like Frontier Communications (NASDAQ:FTR) may boast a high yield, Verizon is outperforming its peers in high-speed Internet growth.

The second reason to buy Big Red is in the most recent quarter, Verizon posted an 11.9% increase in FiOS high-speed Internet subscribers. When you compare this result to the 6.4% increase at AT&T, or the 5.1% increase at Frontier, it's clear that Verizon is growing faster in this important category.

Verizon's premium wireless performance shows up here as well, as the company can offer bundled packages which combine wireless, high-speed Internet, video, and voice services. This so-called "quadruple-play" gives the over 100 million Verizon Wireless customers the ability to pay one bill for all of these services. While AT&T can match this type of offering, Frontier and its local telecom brethren cannot.

Room for improvement and yet still better than the rest
The third reason to buy Big Red is,Verizon carries a higher operating margin than some of its peers, even though its wireline business' margin is much lower. If Verizon can continue to improve the cost structure of its wireline business, the company's earnings could be even more impressive.

Verizon's wireline business carries an operating margin of just 1.3% compared to 9.9% at AT&T and over 17% at Frontier. That being said, Verizon has the opportunity to improve the cost structure of its wireline business. For instance, Verizon's margin before depreciation and amortization is just under 23% compared to almost 29% at AT&T.

Even with these challenges in the wireline division, Verizon's overall operating margin of nearly 39% is significantly better than the near 37% at AT&T or the previously mentioned 17% at Frontier. If Verizon can trim the fat in its wireline business, the company's overall operating margin would rise.

This one isn't even close
Though Frontier's yield of more than 8% might look appealing on the surface, the company's core free cash flow (net income + depreciation-capital expenditures) tells a different story. Using this metric, Frontier used more than 66% of its free cash flow to cover its dividend.

By comparison, AT&T used just under 61% and Verizon used a measly 25% of their core free cash flow to cover their respective payouts. Verizon's lower payout ratio is reason number four to consider the stock. Though Verizon's yield of about 4.4% is less than AT&T at 5.5% or Frontier, the company's payout seems to be significantly safer based on Verizon's cash flow.

Verizon's yield of more than 4% won't grab headlines, but the company's superior performance and substantial cash flow should provide room for increases in the future. Whether you want income or growth in your portfolio, consider adding the Big Red Machine to your buy list.

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Chad Henage owns shares of Verizon Communications. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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