The first full week of the Donald Trump presidency is dawning bleak for Verizon Communications (NYSE:VZ) shareholders -- but don't blame the president. Blame Wells Fargo instead, for downgrading Verizon stock.
Since the 2016 election, Verizon stock has gained 10% versus an S&P 500 gain of just 5%. Unfortunately for investors, while Verizon has outperformed so far, analysts at Wells Fargo see the stock underperforming in 2016, and gaining almost no value at all over the next 12 months. As reported earlier this morning on StreetInsider.com, Wells Fargo has cut its rating on Verizon stock from outperform to just market perform, and cut its target price on the stock to a range of $53 to $55 -- which, at the low end, suggests the stock will enjoy almost no gains at all this year.
1. It's not just about the earnings
First things first: Verizon is scheduled to report Q4 earnings tomorrow, but Wells Fargo wants to make it clear that its downgrade is not a prediction that tomorrow's news will be bad. (Perhaps because, if the news is good, they'll look pretty silly.) Rather, says Wells, it is a warning that "headwinds in 2017" will make it hard for Verizon's stock to keep outperforming the S&P.
Among other things, Wells Fargo fears that Verizon faces "service revenue pressure" and a potential need to spend heavily to acquire more spectrum to maintain its "network superiority" over Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS).
2. Speaking of T-Mobile...
Speaking of these competitors, Wells Fargo is especially worried about the competitive threat from Sprint and T-Mobile (the latter which Wells says is actually its favorite stock in the telecom space -- and which JPMorgan believes may soon merge). T-Mobile just announced that it has rolled up all taxes, surcharges and fees into its monthly subscription price for T-Mobile ONE -- answering customers' pleas that have stretched back for years.
As a result, T-Mobile stands head-and-shoulders above the competition in offering pricing transparency and simplicity. Verizon now has the choice of following suit, potentially hurting its revenue, or standing pat with its plethora of nickel-and-dime fees tacked onto its basic plan pricing, and handing T-Mobile a PR advantage.
3. What it means for Verizon
Either way, Wells Fargo doesn't see a bright future for Verizon, and is cutting its estimates for this year's revenue to $125.5 billion -- a full $1 billion below other Wall Street estimates. Profits-wise, Wells sees Verizon earning about $4 a share this year, which the analyst says works out to a valuation of between $53 and $55 on the stock at a 13.2 to 13.7 times earnings multiple.
This is roughly where the stock has traded over the past 10 years, on average. It's also roughly what Verizon already costs today ($52 and change) -- which is why Wells Fargo doesn't see Verizon stock going up very much at all this year.
Bonus thing: Even the good news is kind of bad
All this being said, Wells Fargo still gives Verizon credit for strong "FCF generation," and still kind of likes the stock for that reason. According to data from S&P Global Market Intelligence, Verizon has generated positive free cash flow of $11.5 billion over the past 12 months. But even here, the news isn't all that great.
$11.5 billion, while nice, is still 18% below Verizon's reported $14 billion in GAAP net income. Put another way, for every $1 that Verizon reports in "earnings," it only produces about $0.82 in actual cash profits. And when valued on free cash flow, this means the stock is actually selling for about 18.7 times cash profits.
That's pretty pricey for a stock that most analysts (again according to S&P Global) think will only grow its profits at about 3% annually over the next five years. That's as compared to a 5% projected growth rate for Sprint, and 9% for T-Mobile US.
All things considered, I think Wells Fargo is probably right to downgrade Verizon.