Company Analysis: Verizon Communications
About the paper
The paper is commissioned to perform financial analysis and equity valuation of Verizon Communications, and issue a final recommendation on the company’s performance. As part of this analysis, we will be using the raw financial figures of 2014 and 2015 and will then run them through the microscope of financial ratios. On the other hand, the equity valuation will be performed using the comparable approach as part of which we will calculate the intrinsic value of the company’s stock using industry PE ratio.
However, before initiating with the financial calculations, we will introduce a brief discussing relating to the company, the industry it operates in, competitors and the associated risk embedded in its business model.
About the industry
Verizon Corporation operates in the telecommunication industry, which offers voice services, data services, data management and cloud computing to the customers. Some of the key attributes of the industry are:
i) US Telecommunication industry is highly concentrated and is majorly dominated by four firms, Verizon Communications, AT&T, Sprint and T-Mobile. In terms of market share, Verizon and AT&T hold a combined market share of 65% of the retail market.
ii) The industry is characterized by high barriers of entry where factors like high capital expenditure, license fee and infrastructural set-up inhibits the entry of new companies.
iii) Industry is counter-cyclical and was one of the few industries that showed growth even during the financial crisis and global slowdown during 2007-08.
iv) US telecommunication industry is getting inclined to infiltrate new markets such as South America, Africa and Asia as these geographical regions are showing immense growth in demand for telecommunication services.
About the company
Founded in the year 1983 as Bell Atlantic Corporation, Verizon Communication is a telecom company headquartered in New York, United States. The company provides wired and wireless services to its 112.1 million customers. By the end of December, 2015, the company was the largest wireless service provider in the United States with a 33% market share and had employed 177,700 individuals.
Competitors
Verizon Communication faces an intense rivalry from companies such as AT&T Inc. , Sprint Communication and T-Mobile. Amongst all of the rival companies, Verizon is closely challenged by AT&T Inc. which holds 32% of the total retail market share compared to 33% of Verizon. Below is a brief financial comparison of Verizon and its competitors:
Risk and associated mitigants
Since the company operates in a dynamic business environment and has a multinational presence, it is exposed to various types of risk. Accordingly, in order to mitigate those risks, the company employs appropriate risk management techniques. Below we have discussed the associated risks and the methods adopted by the company to mitigate those risk factors:
a)Interest Rate Risk
Since the company has borrowed short-term debt and long-term debt on variable interest basis, it is exposed to interest rate risk as part of which even a 100 basic point change in the interest rate can result in higher interest expense payments by the company.
However, in order to mitigate any such risk, the company enters into domestic interest rate swaps to achieve a targeted mix of fixed and variable rate debt. As part of these swaps, the company receives fixed rates and pay variable rates based on LIBOR, resulting in a net increase or decrease to Interest expense. Additionally, the company also enters into forward interest rate swaps to mitigate interest rate risk.
b) Foreign Currency Translation Risk
Since the company has primary operations in Americas as well as Europe, it faces the foreign currency translation risk at the time of translation of financial statements of foreign operations into US dollars, which is the local currency of the company.
Henceforth, in order to mitigate the related risk, the company enters into cross currency swaps for exchanging Euro based payments into US dollar and thus fix the amount which the company will get through foreign operations.
Ratio Analysis
This is the core section of this report as part of which we will be unearthing the financial trends of the company over the past two years using financial ratios. However, in order to achieve comprehensiveness in our analysis, we will be using multiple ratios relating to liquidity, profitability, solvency and efficiency.
-Liquidity Analysis
i) Current Ratio: Current Assets/ Current Liabilities
ii) Quick Ratio: (Cash+ Trade Receivables)/ Current Liabilities
Referring to the above figure, we can see that over the year, the liquidity position of the company has undergone a complete undesired transformation. Beginning with the current ratio, the multiple plummeted from 1.06 to 0.64 on account of -24.09% decrease in the current asset base while the amount of current liabilities surged by 24.90%.
We also tested the liquidity standing of the company using the stringent tool of quick ratio and found the similar trend as the multiple went down from 0.90 to 0.52. The fall here is attributed to -56.78% fall in cash position while the current liabilities increased by 24.90%.
Henceforth, considering the above result, we can see that Verizon Communication has adopted a poor working capital management policy and this raise doubt over the company’s ability to honor its short-term debt.
-Profitability Analysis
i)Operating Profit Margin: Operating Profit/ Revenue
ii) Return on Capital Employed: Net Income/ (Total Assets- Current Liabilities)
After witnessing a bearish trend in the liquidity position of the company, we next analyzed the profitability position and saw strong growth in the profitability position of the company over the year’s time. As for operating margin,the multiple surged from 15.42% to 25.12% on account of 3.57% increase in the revenue figures accompanied by a -20% reduction in the operating cost structure. We also tested the profitability using ROCE and found that the management is making sustainable returns on the capital employed with multiple surging from 4.70% to 8.53%.
Overall, the trend confirms that the management is successful with the operating business model as part of which, higher revenue figures and a prudent cost structure is transforming the managerial efforts into higher profit figures.
-Solvency Analysis
i) Debt-Equity: Total Debt/ Total Equity
ii) Interest Coverage Ratio: Operating Income/ Interest Expenses
With the objective of analyzing the capital structure of the company and the risk embedded within it, we next analyzed the solvency position of the company and found optimistic trends favoring the company. Beginning with the debt-equity ratio, our calculation revealed that over the year, the multiple has decreased from 9.21 to 6.71. This indicates that the company has reduced their reliance on debt funds and accordingly, shareholders are now exposed to lower risk levels.
Another trend that confirms the strong solvency position of the company is the interest coverage ratio, which over the year time has surged from 3.99 to 6.72. This confirms that the Verizon Communication is now more financially capable to honor its debt related obligations.
-Efficiency Analysis
i) Fixed Asset Turnover: Revenue/ Total Assets
For capital intensive industries, such as Telecommunication Industry , the efficiency to utilize the asset base is primarily accessed using the fixed asset turnover. Our calculation here reveals that the over the year, the ratio multiple has surged from 1.41 to 1.58. This confirms that the management is making an efficient utilization of the fixed asset base for generating the revenue figures.
Equity Valuation
As part of our calculation for the intrinsic valuation of the company, we will be using Comparable Approach as part of which, we will be using industry PE and current EPS of the company to calculate the fair value of the company :
-Comparable Approach
-Intrinsic Price= IndustryPE* EPS
= 20.4* 4.37
= $89.14
-Current Price= $51.46
-Result: Undervalued
Conclusion
At the end of this paper, we can conclude that Verizon Communication is an enticing stock to be included in an investor’s portfolio with a high potential of yielding significant returns considering the undervalued status of the stock at the current market price. Moreover, analyzing the past two year performance of the company through the financial ratios, we are also sure of the financial health of the company, which is made up of strong profitability, solvency and efficiency.
Overall, we give a ‘Strong Buy’ recommendation for the stock.
References
Competitors: Verizon Communication. n.d. 2 March 2016 <https://in.finance.yahoo.com/q/co?s=VZ>.
Industry Peers: Verizon Communications. n.d. 2 March 2016 <http://financials.morningstar.com/competitors/industry-peer.action?t=VZ®ion=USA&culture=en_US>.
Statista. Market share of wireless subscriptions held by carriers in the U.S. . n.d. 2 March 2016 <http://www.statista.com/statistics/199359/market-share-of-wireless-carriers-in-the-us-by-subscriptions/>.
Verizon Communication Inc. "Annual Report 2015." Annual Filing. 2015.
