Verizon’s Earnings Hampered by Competitive Pressure on Margins

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Verizon Communications Inc. (NYSE: VZ) reported fourth-quarter and full-year 2014 results before markets opened Thursday morning. The telecom giant reported adjusted diluted quarterly earnings per share (EPS) of $0.71 on revenues of $33.19 billion. In the same period a year ago, Verizon reported EPS of $0.66 on revenues of $31.07 billion. Fourth-quarter results also compare to the consensus estimates for EPS of $0.72 on revenues of $32.69 billion.

For the full year, Verizon reported EPS of $3.35 on revenues of $127.08 billion, compared with EPS of $2.84 and revenues of $120.55 billion in 2013. Analysts were expecting revenues of $126.45 billion and EPS of $3.38.

On a GAAP basis, Verizon reported an EPS loss of $0.54 in the fourth quarter. Fourth-quarter charges totaled $1.25 per share, comprising $1.12 per share related to the company’s year-end mark-to-market adjustment for pension and other post-employment benefits liabilities, as well as severance costs, and 13 cents per share related to the early retirement of debt and other costs.

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Verizon Wireless added 672,000 net retail connections in the fourth quarter, of which all were postpaid (contract) subscribers. At the end of the quarter, Verizon Wireless claimed 35.2 million retail accounts and 108.2 million retail connections. Average revenue per account rose 4.7% year-over-year to $159.73 a month, essentially flat sequentially.

Wireless operating margin in the fourth quarter slipped from 29.5% in the third quarter to 23.5%. Total revenues in the wireless business came in at $23.45 billion, up 11% year-over-year.

Operating margin in the wireless segment fell from 32.1% in 2013 to 30.5% and total revenues rose from $81.02 billion to $87.65 billion.

Revenues up and margins down, not a particularly desirable outcome. Verizon’s operating margin was 35% at the end of the first quarter of 2014 and tumbled more than 10% to finish the year at 23.5%. Competition on pricing from T-Mobile US Inc. (NYSE: TMUS) and Sprint Corp. (NYSE: S) is almost certainly the reason for the decline. Operating expenses rose 20.5% sequentially and 10.6% for the full year. Most of the increase came in cost of services and sales, where Verizon had to accept higher costs in order to keep and attract customers.

In the fourth-quarter’s wireline business, Verizon added 145,000 new Internet connections and 116,000 new video connections to its FiOS fiber network. The company’s wireline business generated $9.56 billion in revenues for the quarter, down 1.6% year-over-year. For the full year wireline revenues were essentially flat.

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The company’s CEO said:

Verizon posted another year of consistently high operating and financial performance in 2014, with strong cash generation and the return of $7.8 billion to our shareowners. I am confident that Verizon’s assets and market momentum position us to continue to drive profitable growth in 2015.

Smartphones now account for 78.6% of Verizon Wireless’ retail customer phone base, up from 70.0% in September. During the quarter Verizon added 1.4 million postpaid tablets to its roster.

Verizon did not offer detailed revenue or earnings guidance, but did say it expects top-line growth of 4% in fiscal year 2015. Based on 2014 revenues of $127.08 billion, that works out to $132.16 billion. The company also said it expects adjusted EBITDA at a level consistent with 2014 performance. For comparison, wireless EBITDA totaled 40% for the year and wireline EBITDA totaled 23.2%.

Consensus estimates for the first quarter call for EPS of $0.94 on revenues of $31.84 billion. For the full 2015 fiscal year, estimated EPS totals $3.69 on revenues of $129.78 billion.

Verizon is feeling pricing pressure from T-Mobile and Sprint and while the company would prefer not to battle for market share it has no choice. T-Mobile’s controlling owner, Deutsche Telekom, appears to understand that the company can fight but that it cannot win. Sprint is likely to come to the same conclusion in the not-so-distant future. There is little question that the fight for subscribers has introduced some serious competition into the market, yet the smaller competitors are bringing knives to a gunfight, and that’s never a winning strategy.

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Shares traded down about 0.4% at $48.04 in premarket trading Thursday, within a 52-week range of $45.09 to $53.66. Prior to this earnings release, Thomson/Reuters had a consensus price target of around $52.20 on the company’s shares.