Better Buy: Verizon Communications Inc. vs. Frontier Communications

By Markets Fool.com


Image source: Frontier Communications.

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Telecom stocks typically give investors high dividend yields, and both Verizon Communications and Frontier Communications have delivered above-average dividend payouts to investors for years. Yet the demands of keeping up with the inexorable advance of technology can take its toll on telecom companies, and price wars in the wireless arena have hurt major cellphone service providers like Verizon even as they have posed challenges to Frontier to retain its legacy landline business. Investors want to know which telecom has the better chance of weathering any future storms in the industry. Let's take a closer look at Verizon and Frontier, comparing them on a number of metrics to see which one looks more attractive under current conditions.

Valuation and share performance

Both Frontier and Verizon have posted positive total returns over the past 12 months, but Verizon has done a better job of rewarding shareholders. Verizon's total return is 26%, compared to just 8% for Frontier, and Verizon's longer-term track record has been stronger than Frontier's as well.

Image source: Verizon.

It's fairly easy to see why investors are happier with Verizon simply by comparing their recent fundamental performance. Verizon sports a relatively cheap valuation of about 13 times earnings on a trailing basis. Even though investors expect a slight pullback in earnings, Verizon's forward earnings multiple is still just 14. By contrast, Frontier has consistently posted net losses, including in the first quarter of this year. Investors don't expect Frontier to become profitable on a GAAP basis through 2017. That makes it difficult to compare the two stocks by earnings-based valuations, but Verizon sports a lower enterprise value-to-sales ratio and arguably has more to justify its share price than Frontier right now.

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Dividends

Both Verizon and Frontier stand near the top of the dividend stock pantheon. Frontier is famous for its high dividend yields over the long run, and its current figure of 8.6% is more than double the 4% yield for Verizon right now.

Yet Verizon's more modest payouts have a couple of things going for them. First, Verizon pays out only about half of its earnings in the form of dividends, while Frontier has routinely drawn on free cash flow even in excess of GAAP earnings to sustain its dividend payouts. In addition, Verizon has been more consistent with its dividend growth, with an 11-year streak of annual dividend increases that have boosted its quarterly payout by nearly two-thirds. Compared to Frontier's nearly 60% drop in dividend payments in the past five years, Verizon gets the nod on the dividend front as well despite its lower yield than Frontier.

Growth prospects and risk

The telecom industry is facing competitive pressures, but there is still strong demand for wireless technology. That has helped Verizon greatly, helping the telecom giant fend off adverse trends elsewhere in its business. In the first quarter of 2016, Verizon reported a modest sales gain of less than 1%, but earnings per share were up a slightly more impressive 4%. The company added 640,000 new postpaid wireless subscribers during the quarter, and churn rates improved to fall below the 1% mark despite numerous offers from rivals seeking to lure Verizon customers away. Growth in FiOS internet connections has slowed, but cost-cutting has helped improve profitability. Looking forward, Verizon expects to be able to sustain its earnings results from past years, but bottom-line growth could prove elusive in the near-term.

Frontier faces more serious challenges. Having just closed on its purchase of wireline assets from Verizon in key areas of Florida, Texas, and California, Frontier has the opportunity to serve new customers totaling 3.7 million voice connections, 2.2 million broadband connections, and 1.2 million pay-television customers. The key to its success is how well it can navigate the transition and keep former Verizon customers within the Frontier fold, and CEO Dan McCarthy is optimistic that Frontier has learned from past mistakes with previous acquisitions and will do a better job with customer retention this time around. Given the pressure of having spent $10.5 billion on the acquisition, Frontier can't afford to fall short. If the company can not only keep those customers but also get them to buy new services, then Frontier has a huge growth trajectory ahead of it.

Right now, Verizon has the edge over Frontier as a better buy, largely because Verizon's prospects are more secure. Frontier needs to prove it can execute on its recent acquisition, but if it can do so successfully, then Frontier stock has a chance of catching up to and surpassing its larger rival in terms of share-price performance.

The article Better Buy: Verizon Communications Inc. vs. Frontier Communications originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.