Despite Near-Term Noise, Wells Fargo Sees Higher Upside in Verizon and AT&T

Some analysts have not been very fond of big telecom and the high dividends that come along with it. Wells Fargo has decided to remain bullish on shares of AT&T Inc. (NYSE: T) with its 5% dividend yield, and the firm has become even more bullish on shares of Verizon Communications Inc. (NYSE: VZ). Wells Fargo’s Jennifer Fritzsche has retained her Outperform ratings on both with above-consensus price targets.

Note that the reports do look for some industrywide bumpiness before the coming upgrade cycle in the second half of 2016. That might lead some into thinking there is more caution, but investors have to consider that it is the job of analysts and investors to look ahead rather than to be surprised about the known trends of the current quarter.

Verizon was said to be seeing soft upgrade activity, with its equipment installment plan (EIP) transition pressuring the first quarter. The firm adjusted its Verizon numbers to reflect a slower first-quarter handset upgrade cycle. Continued service revenue headwinds from its transition from subsidized to the installment-based pricing were cited. Wells Fargo lowered its service revenue to $16.9 billion, down 5.7% from a year ago. This reflects an increasing number of subscribers receiving discounted EIP pricing.

Wells Fargo also lowered its equipment revenues for the first quarter to $4.2 billion, up 25% from a year ago but down from the prior estimate of $4.9 billion. That lower base was primarily on lower first-quarter gross add and upgrade volumes. The report said:

We now expect first quarter postpaid upgrades to be 5.5% of Verizon’s base, down from our previous 6.5% projection. We believe this weakness in upgrade activity is consistent with the trends at the other carriers and reflects the lack of a recent “iconic” device launch. The handset upgrade cycle has also been expanding in length, with consumers increasingly holding onto phones for longer periods. We believe Verizon will reach a positive “inflection” point on service revenue once over 50% of its base is on is counted EIP pricing (currently just over 40%).

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Wells Fargo’s investment thesis for Verizon was as follows:

(1) competitive position should allow it to expand wireless margins and its customer base in 2016,
(2) emerging growth in non-traditional devices and mobile video.

Despite some caution, Wells Fargo’s target price valuation range was raised to $55.00 to $57.00. That is up from $50.00 to $52.00. This is based on growth coming in the second half of 2016 and winning from a move past a subsidized business model. Verizon’s consensus analyst price target is down at $50.50.

Verizon shares were last seen down 0.3% at $53.41. Its consensus analyst price target is $50.50, with a 52-week trading range of $38.06 to $53.85.

AT&T also was given some adjustments to the model, based largely on the industry overall having seen very little handset upgrade activity. Lower equipment revenue was also cited with a lack of any new iconic device launch and with customers holding on to their devices longer now. Wells Fargo estimates that service revenue will grow 0.5% from a year ago, which was represented as the first positive growth since the first quarter of 2014.

Wells Fargo expects more aggressive promotion in the second half of 2016. The firm believes that AT&T has been quiet about its coming promotional efforts intentionally and expects more marketing and promotion in the second half into the launch of DirecTV’s over-the-top wireless video plans. For the first quarter of 2016, Wells Fargo lowered its postpay net add estimate to 250,000 from 300,000, postpay handset losses to -200,000 from a prior -100,000 estimate, and increased tablet adds to 450,000 from 400,000.

Wells Fargo’s valuation range for AT&T remains up at $40.00 to $42.00, based on a 13.3 to 14.0 adjusted earnings per share for 2017. Despite some lower targets and no price target range, Wells Fargo’s Outperform rating for AT&T is based upon its high 5% yield and being the core large-cap holding in the telecom sector.

AT&T shares were last seen up 0.1% at $38.93. AT&T has a consensus target price of $37.89 and a 52-week range of $30.97 to $39.26.