Verizon Vs. AT&T: Only 1 Is A Buy

Verizon (NYSE:VZ) and AT&T (NYSE:T) are both popular battleground stocks on Seeking Alpha right now. Both have dividend yields pushing 8%, both are cheap going by multiples, and both have seen their earnings decline over multi-year periods. As evidenced by the popularity of these stocks on Seeking Alpha, both of them have got dividend investors very interested. AT&T currently has 564,000 followers on Seeking Alpha, while Verizon has 352,000.

It would be tempting to call these stocks two peas in a pod and call it a day. They’re both telcos, they’re both high yield stocks, and they’re both squarely in the “value” category, with rock bottom multiples. However, it would be mistaken to take these two stocks as equivalent.

To begin with, there are operational differences between Verizon and AT&T. First, Verizon’s diversification outside of telecommunications is mainly a 10% stake in Yahoo!, which owns such properties as Tumblr and AOL. AT&T’s main foray outside of the telco universe was its ownership of Time Warner, which was later spun off in an IPO.

Second, AT&T is a little ahead of Verizon in 5G deployment. Currently, AT&T’s 5g network is available to 290 million Americans, while Verizon’s will be available to 200 million by the end of this quarter.

Third and finally, Verizon has fewer serious financial problems than AT&T does. Currently, AT&T is coping with negative tangible book value and interest expenses coming in at a hefty 20% of operating income. Verizon also has negative tangible book value, but a lesser percentage of its equity is goodwill, and its interest expense is only 14.6% of EBIT. On the whole, debt appears to be much less of an issue for Verizon than for AT&T.

In this article I will argue that Verizon is a better buy than AT&T. To do so, I will review the most recent quarterly earnings for each company, as well as their balance sheets, profitability, growth and valuation metrics. On balance, these factors favor Verizon–although there is one category where AT&T scores a win, which I will go over in the next section.

Recent Earnings

To begin our analysis of Verizon and AT&T, we can look at their most recent quarterly earnings side by side. Stock investments are mostly about what companies will do in the future, rather than what they did in the past, so recent earnings (and guidance) are of crucial importance.

Funnily enough, despite my overall preference for Verizon over AT&T, the latter actually had the better Q2 earnings release. I do not believe that AT&T is the better stock overall, but it did have a better showing last quarter. Specifically, it beat Verizon on performance relative to expectations, as well as on growth.

First off, AT&T performed better relative to analyst expectations than Verizon did. It beat on adjusted earnings and was in-line on GAAP earnings. It missed on revenue but only by 0.1%. Verizon on the other hand beat on adjusted earnings, missed on GAAP earnings, and missed widely on revenue.

Secondly, AT&T’s second quarter release delivered better growth than Verizon’s in absolute terms.

In the second quarter, AT&T and Verizon delivered the following revenue, EBIT, and earnings results:

As you can see, AT&T delivered much better revenue and earnings growth than Verizon did in the second quarter. On the other hand, Verizon did have a better free cash flow margin than AT&T did. We could say that Verizon took the cake on profitability last quarter, although the two companies’ EBIT margins were similar. Nevertheless, with AT&T gaining subscribers at Verizon’s expense, growth rates would appear to be the most important metric here. Over time, AT&T would catch up with Verizon’s FCF margin if current trends were to persist.

Balance Sheet Health

Now we get to balance sheet health. This factor favors Verizon over AT&T.

Some key balance sheet metrics for T and VZ are shown below:

From these raw figures, we get the following ratios:

With current ratios, higher is better, so Verizon wins on that one. With debt to equity ratios, lower is better–AT&T scores an optical win on debt/equity. You might think that this is a draw rather than a big win for Verizon, but it pays to look a little deeper. AT&T has $67 billion in goodwill, or 66% of equity. Verizon has $28.6 billion in goodwill, of 30% of equity. So, there is much more goodwill on AT&T’s books than Verizon’s. Goodwill can’t be sold; therefore it is often excluded from the calculation of balance sheet ratios. If we make this adjustment, then Verizon beats AT&T on the debt/equity ratio as well as the current ratio, and on balance sheet strength overall.

Growth

Next up we have the growth factor. As mentioned previously, this factor favored AT&T last quarter. However, on a long term basis, Verizon wins here too.

Below you will see several growth metrics for Verizon and AT&T side by side (both ttm and 5-year CAGR):

As you can see, Verizon’s growth was much better than AT&T’s in the trailing 12 month period and over the last five years. AT&T scored a win in the most recent quarter, but not in the last 12 months, or even over the last 5 years. To be sure, T’s faster rate of subscriber addition could eventually result in it catching up with Verizon and make a long term trend out of the most recent quarterly showing. But with its better financial picture, VZ has a lot of options when it comes to recruiting new subscribers. I would not take last quarter to be the start of a trend just yet.

Valuation

Finally, we get to valuation, a factor that VZ and T both score quite well on. The following are some valuation multiples for VZ and T, courtesy of Seeking Alpha Quant:

AT&T’s multiples are certainly lower than those of Verizon, but then again Verizon had better growth in the trailing 12 month period. If long term trends persist, then Verizon’s multiples at today’s prices will not look like they were excessive. Over the last five years, VZ’s revenue has grown, AT&T’s has declined. So, factoring growth into the equation, AT&T may not be cheaper than Verizon after all.

One Risk to Watch Out For

Owing to Verizon’s better financial position, I have rated it a ‘buy,’ while rating AT&T just a hold. I think that, for the most part, Verizon will outperform AT&T long term.

However, there is one risk for VZ shareholders to watch out for:

AT&T gaining subscribers at the expense of Verizon.

In its most recent quarter, VZ grew its postpaid net mobile additions by 8,000 and its internet additions by 418,000. AT&T on the other hand delivered 318,000 in net phone additions and 250,000 in internet. VZ’s additions totaled 426,000 while T’s totaled 568,000. So AT&T won the new subscriber sweepstakes last quarter. The long term picture tells a different story, but VZ investors will want to keep an eye on this trend, hoping to see it slow down. Over a long enough period of time, subscribers ultimately drive the bottom line at telcos.

Nevertheless, on balance, I prefer Verizon to AT&T. VZ’s balance sheet is healthier, it has grown faster, and its valuation and dividend yield are comparable to T’s. To be sure, T has a few factors going for it. But VZ looks like the overall better buy.