Friday, September 28, 2012

Verizon Vs. Vodafone--Go With the Brits

Verizon has been a widely popular income stock in the U.S.  Until its rise this summer, the stock's dividend yield was more than 5%, at a time when cash yields almost nothing and bond yields have been near record lows.

Its Verizon Wireless business is an effective duopoly with AT & T in the U.S. wireless communications business.  However, closer examination reveals a stock with little appeal, particularly compared to Vodafone of the U.K., which owns half of Verizon Wireless.

After rising 23% over the past year, Verizon shares now have a dividend yield of 4.5%.  But the dividend payout ratio (as a percent of earnings per share) is an extraordinarily high 80%.  (I generally avoid income stocks with dividend payout ratios above 50-55%, unless earnings are temporarily depressed or earnings growth is expected to accelerate.)  In addition, the valuation of Verizon is quite poor.  Verizon trades at 18 times estimated 2012 earnings per share, a substantial premium to the market despite having profit declines in two of the past three years.

Verizon's balance sheet also is quite poor.  When adding the company's $32 billion of unfunded pension obligations to its outstanding debt, its debt/equity ratio is 200%.  But Verizon also has $103 billion of "goodwill" and other intangible assets on its balance sheet.  When subtracting this amount from its shareholders equity (or net worth), the company's tangible book value per share is minus $23 (half of the share price).  On the plus side, the cash generation from its businesses is quite good, and the free cash flow yield after capital spending and paying a sizable dividend is 7% (quite high relative to other stocks currently).

Vodafone, the owner of the other half of Verizon Wireless, seems a superior investment to Verizon.  Its dividend yield is 5.2% with a dividend payout ratio of 57%. That dividend could be supplemented by another special dividend paid later this year or early next year if Verizon Wireless pays another dividend to its owners, Verizon and Vodafone.  

Vodafone's valuation is quite good, at only 11 times estimated 2012 earnings per share.  Expectations for the stock are low, with earnings expected to be flat for the next two years because of the company's European exposure.  Unlike Verizon, Vodafone's pension is effectively fully funded.  Its debt ratio is only 34% of shareholders' equity, and after subtracting intangible assets, it has a positive tangible book value per share.  The company generates less free cash flow than Verizon, but Vodafone's CEO intends to sell assets, increase the dividend, and repurchase shares on the open market to help the stock, which has been a laggard.

At a time when a surge in stock prices over the summer has left few remaining good values, Vodafone is an exceptional value--and it is one of the best dividend-paying stocks in the world.

Steve Lehman

VOD:  $28.40
VZ:  $45.40

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