Verizon (NYSE: VZ) and Philip Morris International (NYSE: PM) both generate stable earnings growth and pay high dividends. They also have wide moats: Verizon is one of America's top telecom companies, and PMI is one of the world's largest tobacco companies.
Those qualities have traditionally made Verizon and PMI good stocks for conservative investors. But over the past five years, Verizon's stock advanced nearly 30% as PMI's stock stayed nearly flat. Let's see why the telecom company outperformed the cigarette maker, and whether or not that trend will continue in the future.
Verizon's near-term challenges
Verizon generates most of its revenue from wireless hardware and services. That core business struggled with slower sales of smartphones and competition from rival carriers last year, and the COVID-19 crisis exacerbated that pressure in the first half of 2020.
A smaller percentage of Verizon's revenue comes from its wireline business, which was downsized in recent years to free up more resources for its higher-growth wireless segment, and Verizon Media, the advertising segment that houses AOL and Yahoo's internet assets. Unlike top rival AT&T, Verizon isn't trying to digest a massive media business or building an expensive streaming video ecosystem.
Verizon's operating revenue rose just 1% in 2019, as weak sales of wireless hardware offset its stable growth in wireless services, and declined 3% year-over-year in the first half of 2020 as the pandemic shut down businesses and reduced Verizon Media's advertising revenue. Its adjusted EPS, buoyed by buybacks, rose 2% last year and stayed nearly flat year-over-year in the first six months.
Verizon didn't provide any revenue guidance for the full year, but it expects its adjusted EPS to stay roughly flat. Analysts expect its revenue and earnings to decline 3% and 1%, respectively.
That outlook seems dim, but new 5G smartphones, Verizon's expansion into connected cars and Internet of Things devices, and ongoing fiber upgrades could generate fresh growth next year as the pandemic ends. That's why Wall Street expects Verizon's revenue and earnings to both rise 3% in 2021.
Philip Morris' longer-term challenges
PMI, which split from its domestic counterpart Altria over a decade ago, generates all its revenue overseas. PMI focuses on selling its flagship cigarette brands, including Marlboro, in countries with higher smoking rates, lower excise taxes, and fewer restrictions on tobacco use.
However, smoking rates have continued to decline worldwide, and many of those higher-growth markets have hiked their taxes and tightened their regulations. Currency headwinds also frequently throttled PMI's growth.
PMI raised its prices and cut costs to offset those lower shipments. It previously repurchased its shares to boost its earnings, but it halted those buybacks five years ago amid unfavorable currency headwinds. PMI also diversified away from cigarettes with its iQOS devices, which heat up sticks of tobacco instead of burning them.
PMI's iQOS shipments are rising, but its traditional cigarette shipments are still declining. Nonetheless, PMI's revenue still grew 6% on a like-for-like basis last year as it raised its cigarette prices and expanded iQOS into new markets. On the same basis, its adjusted EPS rose 2%.
In the first half of 2020, PMI's revenue dipped 0.5% on a like-for-like basis, but its adjusted EPS rose 8% on the same basis as it raised prices and cut costs again. PMI didn't provide any revenue guidance for the full year, but it expects its adjusted EPS to rise 2%-5% in constant currency terms. Analysts expect its reported revenue and earnings to slip 4% and 2%, respectively, for the full year.
But in 2021, Wall Street expects PMI's revenue and earnings to grow 7% and 10%, respectively, as the pandemic passes, retailers reopen, and it continues to expand its higher-growth iQOS business.
The valuations and dividends
Verizon trades at just 12 times forward earnings, and PMI has a forward P/E of 16. Both stocks are fundamentally cheap because investors aren't expecting much near-term growth from either company.
Both companies have raised their dividends annually for over a decade, but Verizon's forward dividend yield of 4.1% is lower than PMI's 5.9% yield. However, Verizon only spent 48% of its free cash flow on that dividend over the past 12 months, while PMI's dividend consumed 93% of its FCF -- which limits the range of its future dividend hikes.
The winner: Verizon
Verizon might initially seem like a weaker investment than PMI, due to its slower projected growth rate for 2021 and its lower dividend yield, but its core market won't shrink over the long term like PMI's market of smokers.
Verizon should start to generate slow but steady growth again after the COVID-19 crisis ends, but analysts' forecasts for PMI next year could be too optimistic. PMI may generate decent growth in 2021, thanks to easy year-over-year comparisons, but its iQOS shipments won't offset its tumbling cigarette shipments anytime soon.
Over the long term, PMI's earnings could decline as it runs out of room to raise prices and cut costs. Keeping that in mind, it's clearly safer to stick with Verizon than Philip Morris International.
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Leo Sun owns shares of AT&T. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
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