Better Buy: CenturyLink, Inc. vs. Verizon

Markets Motley Fool

Comparing American telecom players Verizon Communications (NYSE: VZ) and CenturyLink (NYSE: CTL) to one another is like comparing the Major Leagues to Triple-A. They technically play the same sport, but they operate at entirely different scales.

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Thankfully, in the investing world, stocks of all shapes and sizes can make for potential buys; we're equal-opportunity investors here at the Fool. So keeping that in mind, let's look at CenturyLink and Verizon across three important categories to determine which company looks like the more appealing investment today.

Financial fortitude

As a baseline, investors need to first understand the financial stability of any prospective investment before digging into its broader growth and valuation narratives. To guide this analysis, let's look at four metrics to get a sense of how Verizon and CenturyLink stack up in terms of liquidity and solvency.

Company

Cash & Investments

Debt

Cash From Operations

Current Ratio

CenturyLink

$214 million

$19.6 billion

$4.2 billion

0.9

Verizon

$4.3 billion

$116.8 billion

$16.9 billion

1.0

The aforementioned difference in scale between the two comes into sharper contrast here. However, it should also jump out that, though they differ quite dramatically in absolute size, CenturyLink and Verizon share fairly similar capital structure and cash flow generation profiles. The two companies share virtually identical current ratios. Beyond that, CenturyLink carries just 1.1% of its total debt load in cash and investments, whereas Verizon holds 2.6% of its borrowings in liquid assets -- not much difference there.

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Alternatively, CenturyLink's 12-month cash flow from operations represents 21.4% of its total debt, whereas Verizon's cash flows only account for 10.1% of its $116.8 billion in debt. Granted, Verizon enjoys an investment-grade credit rating versus CenturyLink's non-investment-grade rating, so Verizon's cost of borrowing is likely lower. However, since the two share so much in common in terms of their financial footprint, it seems fairest to call this section a tie and move on.

Winner: Tie

Durable competitive advantages

Here's where the differences between the two start to really hit home. As the largest wireless provider in the U.S., Verizon's business model is largely predicated on providing wireless services to consumers and businesses -- $89 billion of its $125 billion in fiscal 2016 revenue came from wireless. 

Though the U.S. wireless market is no longer growing as fast as it once was, the space is generally stable. Alongside the other U.S. wireless monolith AT&T, Verizon's massive financial resources should allow it to effectively compete against continued competition from T-Mobile and Sprint.

Moreover, the company is attempting to align itself with the broader trends in the wireless industry, most notably by buying its way into mobile advertising via its AOL and Yahoo acquisitions. For the record, I like AT&T's growth strategy more, but there's little reason to fret over Verizon's long-term place as a central player in this space.

CenturyLink, on the other hand, finds itself in a slightly more precarious situation. In fact, $7.6 billion of the company's $17.4 billion in 2016 sales come from what CenturyLink calls its legacy services segment, which mostly consists of landline phone services for companies and consumers. As the company itself notes, this business is expected to remain in secular decline as the use of landline phones continues to dwindle. The remaining majority of CenturyLink's revenue comes from providing broadband and other data connectivity services to companies and individuals, which isn't necessarily a growth market either.

The company hopes to shore up its competitive position via its pending merger with Level 3 Communications. The $34 billion deal should help expand CenturyLink's presence in the broadband service market and provide considerable cost savings. To be clear, this move is undoubtedly a smart one. However, it doesn't change the company's fundamental problem that it is largely tied to competitive markets that seem likely to decline over time.

Winner: Verizon

Valuation

Looking to the final section of our analysis, let's start by reviewing three popular valuation metrics for Verizon and CenturyLink.

Company

P/E

Forward P/E

P/Cash Flow

CenturyLink

15.6

12.2

12.3

Verizon

25.2

12.5

11.8

Let's also tie in analysts' consensus growth estimates here to provide a bit more context about each company's valuation. Wall Street expects Verizon's sales to decline 2.7% this year and grow 0.5% next year. For CenturyLink, the analyst community sees its sales falling 5.4% this year and 1.8% next year. In this light, Verizon's higher current P/E starts to appear more favorable, and its forward multiples seem more enticing.

Lastly, any discussion of these two telecom names would be remiss without looking at their dividends, one of the hallmarks of telecom investing. Verizon currently pays out a comparatively lower 4.9% dividend, and its dividend payout ratio stands at 76% of net income. CenturyLink pays out an 8.5% dividend with a 211% dividend yield, which seems rather aggressive. Ultimately, a safer dividend can be better than a higher yield. Verizon wins this final portion of our analysis.

Winner: Verizon

And the winner is...Verizon

Apologies to the CenturyLink fans in the crowd, but Verizon is simply a higher quality business in terms of its current strategy, its size within the space, its growth outlook, and the sustainability of its dividend. To be sure, CenturyLink's Level 3 buyout should help the company improve the efficiency of its operations. However, in thinking about which company you see thriving over the long term, Verizon is the clear winner in this matchup of telecom industry powers.

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Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.