This Stock Bundles Growth and Value

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

DirecTV (NASDAQ: DTV) reported 4Q11 results on Thursday that are being viewed negatively by the market.  The stock was down 2% following results against a 1% advance in the broad market despite easily surpassing consensus expectations.  Management shifted strategy a bit and I think that caught investors off guard -- change generally being feared. 

The new strategy is to focus the growth on Latin America, where DTV has a dominant, fast-growing market position.  The United States will be more about retention with the anticipation of mid-single digit revenue growth in the coming years.  I love the move and think it makes the stock an even better choice than when I first mentioned it here.

DirecTV reported 4Q11 EPS of $1.02 versus consensus expectations of $0.92.  That is a big beat!  For the year, earnings-per-share advanced 40%!  But these great results are being questioned by analysts and investors.  The company produced 715,000 net adds in the fourth quarter alone and beat expectations; however, the U.S. was much slower than expected (+125,000) and Latin America hit a grand slam (+590,000). 

So what is the problem? It is competitive in the United States and the cost to add additional new subscribers continues to escalate.   I think management is making a great decision to maximize return on capital by not plowing excessive amounts of money into limited growth opportunities domestically.  That could not only cause low returns on capital, but would also cause the company to lose focus on retention and be a double-edged sword.    

Recap

DirecTV is the world’s largest provider of pay television services in the world with more than 32 million subscribers.  They are number two in the United States behind Comcast (NASDAQ: CMCSA).  They generated more than $27 billion in revenues in 2011 -- 80% U.S. and 20% Latin America.  The company is shifting to a retention strategy in the United States, which should yield modest revenue growth from slightly increasing average revenue per user and incremental services.  Latin American revenues grew 25% in 2010 and then accelerated off that base to grow 42% in 2011!  The company also announced a $6 billion share repurchase plan and is targeting EPS above $5.00 in 2013, a 20% annual advance.  And that $5.00 target isn’t a reach given the average estimate among 14 analysts is $5.28 with a range of $4.97 to $5.51. 

Valuation

DTV has done a superb job with increasing return on invested capital, the key ratio for operating performance.  They finished 2011 with ROIC of 25% and that ratio has set a new high in five of the last six years.  EBITDA margins are an enviable 25%.  For this performance and 20% EPS growth in the next two years an investor must only pay 13x earnings.  That is a pretty compelling valuation from an earnings standpoint. 

The one knock on the stock, and I think it is temporary, is that the free cash flow yield (free cash flow divided by enterprise value) fell from 6.7% in 2010 to 4.5% in 2011 due to an increase in capital expenditures.  Capex should be flat in 2012 with cash flow from operations moving up.

How does DTV stack up against its three closest peers?  Comcast, Dish Network (NASDAQ: DISH) and Time Warner Cable (NYSE: TWC)

Comcast is the largest cable provider in the United States with more than 22 million video customers.  They also offer internet and phone services.  The vast majority of their profits come from providing these services, but they do have a presence in cable content via NBC Universal.  Dish Network is the third largest pay TV company in the U.S. with about 14 million subscribers.  Time Warner Cable is the fourth largest video provider in the U.S., but like Comcast, provides high-speed internet and phone service.

<table> <tbody> <tr> <td> <p>Stock</p> </td> <td> <p>P/E</p> </td> <td> <p>EV/EBITDA</p> </td> <td> <p>FCF Yield</p> </td> <td> <p>ROIC</p> </td> <td> <p>Consensus 2-year EPS growth</p> </td> </tr> <tr> <td> <p>DTV</p> </td> <td> <p>13</p> </td> <td> <p>6.4</p> </td> <td> <p>4.6%</p> </td> <td> <p>25%</p> </td> <td> <p>23%</p> </td> </tr> <tr> <td> <p>CMCSA</p> </td> <td> <p>18</p> </td> <td> <p>7.1</p> </td> <td> <p>1.5%</p> </td> <td> <p>5%</p> </td> <td> <p>20%</p> </td> </tr> <tr> <td> <p>DISH</p> </td> <td> <p>10</p> </td> <td> <p>5.1</p> </td> <td> <p>9.0%</p> </td> <td> <p>30%</p> </td> <td> <p>12%</p> </td> </tr> <tr> <td> <p>TWC</p> </td> <td> <p>13</p> </td> <td> <p>6.4</p> </td> <td> <p>5.9%</p> </td> <td> <p>7%</p> </td> <td> <p>22%</p> </td> </tr> </tbody> </table>

It is clear that DTV stands out against Comcast and is more comparable to Time Warner Cable.  I prefer the growth opportunities afforded DTV and their high returns on capital over Time Warner Cable.  Dish is super cheap, but looking under the hood reveals exactly why.  The company is hemorrhaging customers.  They report 4Q results later this month, but have had net subscriber losses in five of the last six quarters.  From 2Q10 to 3Q12 Dish lost 392,000 net subscribers whereas DirecTV added 1.1 million!

Bottom Line

DirecTV stock offers both value and growth.  Management has already lowered the bar on U.S. growth so investors don’t need to worry about getting blinded by that in the future.  Instead, they can reap the growth in Latin America while also achieving steady cash flow from the U.S. operations.  The stock is ideal for investors with longer holding periods that are seeking market-beating returns. 


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