With domestic wireless markets maturing, is Verizon Communications Inc. (NYSE:VZ) about to peak? The slow growing company has already gained roughly 40% in the last 12 months and has gone near parabolic this year jumping $11 in the last few months. Just how high can this stock go now that it has an enterprise value approaching $200 billion trade?
Verizon is a leading domestic telecommunications company with a 55% ownership stake in Verizon Wireless. The company remains in an on-and-off discussion to purchase the remaining 45% of Verizon Wireless from Vodafone Group Plc (ADR) (NASDAQ:VOD).
Competition in the sector appears to be heating up again as Sprint Nextel Corporation (NYSE:S) reinvents itself and T-Mobile has become a legitimate fourth player in the sector after finally gaining access to the iPhone.
Worrisome Signs
Wireline revenue declined by 1.2% as expected and is not considered an issue as long as the pace down is steady. The bigger concern that is the number of wireless retail postpaid accounts dropped, retail net adds were smaller, and wireless 4G devices added during the quarter were the second smallest in the last year.
All of these metrics point to a market saturating. With limited new customers in the mix, margins will be squeezed if Sprint Nextel Corporation (NYSE:S) or T-Mobile are successful in attracting away customers.
Encouraging Sign
The most encouraging sign is that capital spending was flat with last year allowing free cash flow to soar. If Verizon Communications Inc. (NYSE:VZ) is able to keep capital spending at bay, it will be able to keep the cash flow going.
Verizon reported a 64% increase in free cash flow to $3.9 billion in Q1 2013. Last year it only generated $2.4 billion in free cash flow. As the slide below indicates, even with this bullish development the debt load actually increased to $52.9 billion last quarter. This massive debt load is one of the problems with the 3.9% dividend. The company is not being financially prudent by paying that big of a dividend while accumulating debt.
Increased competition
Just as Verizon has right-sized capital spending, back come Sprint and T-Mobile as competitive threats. For the last few years, Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (NYSE:T) had a virtual duopoly as the two smaller wireless providers failed to remain competitive. Now Sprint has turned around with several potential strategic investors. T-Mobile is in the process of merging with MetroPCS Communications Inc (NYSE:PCS) and amongst other stuff now has the much-desired iPhone to offer.
Sprint is in the process of evaluating a new bid from DISH Network Corp. (NASDAQ:DISH) after originally agreeing to an offer from Softbank, which included a deal to sell 70% of its shares to Japan’s SoftBank Corp for $20.1 billion. DISH Network Corp. (NASDAQ:DISH) offered to pay $25.5 billion for the whole company. Either version provides Sprint with a cash infusion or access to a bigger balance sheet to compete in the sector.
T-Mobile is in the process of merging with MetroPCS Communications Inc (NYSE:PCS) to make a formidable competitor to the duopoly of AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ). In addition, at the end of last year it received $2.4 billion in a deal to sale and leaseback cell towers. The more interesting news is that since T-Mobile has been late to the 4G LTE game, Venturebeat reports that it will have a step up on the new 5G technology labeled LTE Advanced. With the newest 4G gear installed, T-Mobile will require a smaller upgrade of infrastructure than those that installed it one to two years ago.
Conclusion
As with most high yielding stocks, Verizon is reaching lofty levels with the stock trading at 16.5x next year’s earnings. Ironically the stock has reached multi-year highs right as the competition is heating up. The dividend has also reached multi-year lows at only 3.9% signaling investors need to tread lightly. While the company has been able to hold capital spending in check lately, the recent movements of Sprint and T-Mobile will pressure Verizon Communications Inc. (NYSE:VZ) back into the arms race. Another sign that the $53 billion in debt provides limited comfort as long as competitors are racing to install the latest technology. After leading the market into 3G and 4G network upgrades, the next technology advancement might be more competitive.
The article Is Verizon About to Peak? originally appeared on Fool.com and is written by Mark Holder.
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