(VZ) Verizon Communications Third Quarter 2012 Earnings Preview

The largest U.S. mobile service provider Verizon Communications Inc. (VZ) is slated to release its third quarter 2012 earnings before the opening bell on October 18. The current Zacks Consensus Estimate is pegged at 65 cents for the third quarter, representing a year-over-year increase of 16.58%.

With respect to surprises, Verizon has a 0.81% average positive earnings surprise in the past four quarters. However, the company had reported in-line results in the year-ago quarter.

The company did not release any financial forecast for the third quarter during its second quarter conference call. However, for fiscal 2012, the company expects to generate double-digit earnings growth of 10% banking on continued healthy wireless and improving wireline margins. Verizon also estimates capital expenditures to be flat or down from $16.2 billion reported last year.

Second Quarter Flashback

Verizon once again generated double-digit earnings growth and significant cash flow growth in the second quarter. Though adjusted earnings was at par with the Zacks Consensus Estimate, it was above the year-ago earnings by 7 cents. Revenue improved on continued strong wireless services, FiOS fiber-optic services and strategic services.

Wireless revenue advanced on the back of strong data revenues and high retail post-paid average revenue per user (ARPU). Despite the sluggish growth in the U.S. mobile market, rapid expansion of 4G LTE services, strong sales of Apple Inc.’s (AAPL) iPhone and strong adoption of Google Inc.’s (GOOG) Android smartphones led to the growth in retail wireless subscribers. Retail post-paid churn (customer switch) was lowest in four years at 0.84% in the second quarter.

Despite the solid momentum for FiOS fiber-optic network and strategic services, Wireline revenue dipped on continued declines across global business. The penetration rate of both FiOS Internet and FiOS Video accelerated to approximately 36.6% and 32.6%, respectively.

Agreement of Analysts

Estimates reflect a negative bias for both the third quarter and fiscal 2012 over the last 30 days. For the third quarter, 7 out of 28 analysts made downward revisions while one moved in the opposite direction. For fiscal 2012, out of the 32 analysts covering the stock, 4 revised their estimates downward while 1 revised it positively.

The analysts are cautious about both the Wireless and Wireline profitability on the back of the numerous actions taken by the company.

Just before the third quarter started, the company unveiled new shared data plan – Share Everything – for its wireless services. Though Verizon’s unlimited facility and shared data component would aid in making the plans popular leading to higher demand, the new offer contains higher fee that could limit the monthly ARPU growth in the short term.

Verizon has finally won the approval for its spectrum deals with a group of cable companies, including Comcast Corporation (CMCSA), Time Warner Cable Inc. (TWC) and Bright House Networks, and Cox Communications. The company has also completed its swap deal to acquire spectrum from the low-cost wireless service provider Leap Wireless (LEAP).

These transactions further strengthen Verizon’s position against its major rivals Sprint Nextel Corp. (S), which is a turnaround story, and AT&T Inc. (T), which is still in need of additional airwaves. Though the spectrum deals would be accretive to Verizon in the long term and reshape the overall telecommunication industry when demand for smartphones is at its peak, the analysts believe that the deals might put pressure on the balance sheet in the short term due to reduced cash balances and increased capital expenditures.

Finally, Verizon started offering the hot iconic iPhone 5 starting late last month of the third quarter. Though iPhone 5 is likely to be the most popular product, it would dilute margins in the short term owing to lofty subsidies. In fact, subsides might outweigh other benefits from the product like customer additions and higher average revenue per user.

On the wireline front, the new FiOS pricing would lead to lower subscription, as it has imposed a burden on customers to pay an extra $10–$15 per month for bundled television and broadband service. As a result, the FiOS subscriber growth is expected to remain stable in the third quarter.

Additionally, Verizon is seeking new ways such as FiOS Quantum, copper-to-fiber migration and cost-cutting measures to drive FiOS revenue growth and maximize profitability. These initiatives nevertheless would restrict near-term FiOS subscriber additions. As a result, wireline revenue trends would remain challenging over the next couple of quarters. Further, Verizon is struggling with persistent losses in access lines that are weighing on its revenues and margins.

In brief, the number of initiatives taken by Verizon to bolster long-term profitability would result in some dilution in the short term. The growing free cash flows and falling capital efficiency (capital expenditure-to-revenue ratio) has compelled the company to boost annual dividend by 3% to $2.06 per share for the second half of fiscal 2012.

Magnitude — Consensus Estimate Trend

The magnitude of earnings revisions for the third quarter slid by a penny over the last 7 and 30 days.

The Zacks Consensus Estimate for 2012 remains unchanged at $2.48 over the last 7 and 30 days.

Neutral Recommendation

We believe Verizon is poised to grow its revenue and earnings this year based on the introduction of new smartphones, tablets and data devices in the wireless segment and continued expansion of robust FiOS fiber-optic network and strategic services, including cloud-computing business, in the wireline business. These will continue to drive the company’s growth prospects going forward.

Nevertheless, we remain skeptical about returns from the 4G wireless and wireline FiOS networks, persistent access line losses, heavy iPhone subsidies and intense competition from cable companies and other alternative services providers

We are currently maintaining our long-term Neutral recommendation on Verizon. For the short term (1-3 months), the stock retains a Zacks #3 (Hold) Rank.

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