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Morningstar | Verizon Posts Soft 4Q Earnings Despite Strong Customer Gains

The wireless customer growth Verizon disclosed on Jan. 8 was the highlight of its fourth-quarter performance. While those metrics were strong, the remainder of the firm’s results were modestly disappointing, in our view. Revenue per wireless customer, which had shown solid improvement earlier in 2018, took a step back during the quarter. In addition, profitability in the fixed-line segment, which is admittedly increasingly difficult to isolate as the lines between services blur, took a huge step down. Overall, we don’t expect to materially alter our $58 fair value estimate, and our view of Verizon’s competitive position is unchanged.

Verizon had previously disclosed that it added 653,000 postpaid phone customers during the quarter, its strongest net gain in four years. The firm also added 118,000 net new postpaid accounts during the quarter, taking total additions for the year to 23,000, a welcome change from the net account losses reported in 2016 and 2017. Average service revenue per account was soft, though, declining 0.5% year over year, limiting wireless revenue growth to 2.1%, adjusted for accounting changes. Management claims the trends that have improved revenue per account recently, including the adoption of unlimited plans, remained in place during the quarter, offset by one-time items like billing credits to those affected by natural disasters. That explanation makes sense given the amounts involved are small, but we’d still like to see increased pricing along with customer gains.

We believe Verizon is competing well, particularly against Sprint and AT&T, but the market remains somewhat challenging in our view as Sprint and T-Mobile chase growth. Verizon’s industry-best cost structure leaves it well prepared to weather the competitive environment. Wireless operating income increased 4.5% year over year during the quarter, with the operating margin expanding about 1 percentage point.

In the fixed-line segment, revenue declined 3.5% year over year, a slight improvement versus the past couple quarters on relative strength in the consumer, small business, and enterprise segments. The wholesale business, on the other hand, posted another sharp drop in sales. The enterprise and wholesale businesses tend to be lumpy, so it's hard to read much into one quarter’s performance, but management seems happy with the progress the firm has made recently migrating to new technologies, including SD-WAN, and winning new business. In the consumer segment, the Internet access business remains stable, but the television business is shedding customers at an accelerating rate.

Fixed-line profitability is a cause for concern, as the EBITDA margin declined more than 4 percentage points year over year to 17.6% and the segment turned in a $273 million loss for the quarter. Management offered little explanation for the sharp decline, pointing only to the revenue decline and increased content costs. However, neither of these trends are new, and, if anything, they have eased somewhat as Verizon has lost television customers. The firm does expect that its voluntary employee separation program, enacted in late 2018, will have a sizable impact on fixed-line costs. We suspect that the fixed-line business has become increasingly difficult to separate from Verizon Wireless as the firm builds fiber deeper into its networks, meaning that some fixed-line pressure is to the benefit of the far larger wireless business.

On a consolidated basis, Verizon reported 0.5% revenue growth year over year for the quarter and 3.5% for 2018, adjusted for accounting changes. Wireless equipment revenue declined 2.1% during the fourth quarter on a step down in the percentage of customers upgrading phones, in line with recent industry trends, as seen in Apple’s relatively weak sales volumes. Free cash flow totaled $17.7 billion for the year, up from $8.1 billion in 2017 thanks to lower cash taxes, capital spending, pension contributions, and working capital outlays. The firm returned $9.8 billion to shareholders in dividend payments, using the remainder primarily to repay debt. Net debt declined to $110 billion from $115 billion a year ago, taking net leverage to 2.3 times EBITDA from 2.6 times.

Looking ahead, management expects 2019 capital spending will increase slightly versus 2018, with cash taxes increasing $2 billion-$3 billion. We expect growth in the business can at least partially offset these headwinds, allowing free cash flow to remain near 2018 levels. We also expect Verizon will continue to use excess cash flow to drive leverage lower in 2019.