Potential Dividend Trouble and What to Buy Instead

By Chad Henage - September 8, 2012 | Tickers: CBS, CMCSA, TWX, DIS | 0 Comments

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When you say the business name Time Warner (NYSE: TWX), the first thing that comes to most people's minds is the failed merger with AOL. This merger has been used as an example of what not to do, and as proof that just because two big companies get together there isn't always synergy to be realized. However, since the split with AOL, Time Warner has gotten back to its roots of running television stations, publishing, and movie production. What's strange is, it's almost as though there is still an overhang from the failed AOL merger. Time Warner is still not performing as well as their primary competitor Comcast Corporation (NASDAQ: CMCSA). Let's take a look at the company's most recent earnings report, and I'll show you a few trouble spots, and give you suggestions of what other companies might be better investments.

The Strongest Division Couldn't Save Overall Results:

In the entertainment industry where Time Warner competes, there are multiple companies that investors could consider as better alternatives. Not only does Time Warner compete with companies like Comcast, but other conglomerates such as Walt Disney (NYSE: DIS) and CBS Corp. (NYSE: CBS) as well. Time Warner's three primary networks are HBO, TNT, and TBS. These networks represent the largest portion of Time Warner's revenue generation, and were the best part of the company's recent earnings. The Networks division revenue increased 4.26% and income was up 9.26%. While these results are okay, they could not save the company's overall performance from slipping versus last year. On an overall basis, revenues were still down 4% and adjusted operating income decreased 5%.

Walt Disney #1 with Time Warner and Comcast Tied for #2:

Time Warner's Film and TV Entertainment unit showed revenue down 8.18%, and income dropped almost 16%. This was due to difficult comparisons versus last year when the company had the benefit of Harry Potter and the Deathly Hallows: Part I. With this unit representing just less than 39% of total revenue, you can see why the overall company struggled. In addition, the company's Warner Bros. films entertainment division seems to be a weak spot relative to their competition. For the remainder of 2012, the strongest release this division has upcoming is, The Hobbit: An Unexpected Journey. Next year the company has three blockbuster films announced, those being Man of Steel, a 300 sequel, and The Hobbit: There and Back Again. While this is in line with what Comcast's Universal Pictures has lined up, it seems like a weaker slate of pictures than what Walt Disney has planned. Disney appears to be the strongest of the three movie studios with sequels to Iron Man, Thor, Pirates, and Monsters, Inc. due out, as well as another Phineas and Ferb movie. Based on the strong sequel lineup investors looking for a big pop in studio revenue would be well served to consider Walt Disney as the best option.

Publishing is What it Is:

The company's Publishing division also was a challenge with revenue down 9.3% and income dropping by 42.6%. While Publishing represents less than 13% of total revenue, this certainly did not help results either. Unfortunately for Time Warner shareholders, the struggles in two of the three major divisions caused significant underperformance in the company's financials.

Potential Dividend Trouble and Less Share Repurchases:

If there is one primary argument against investing in Time Warner, it has to be the company's financial performance. There is a challenge to the company's dividend that I have not heard many people report on. For instance, last year the company generated just barely enough free cash flow to cover dividend payments, with a payout ratio of almost 97%. In the first six months of 2012, this issue has gotten worse, as the company's free cash flow payout ratio has risen to 109%. While Time Warner has been retiring shares and has decreased its diluted share count by over 10%, without a major change in the company's free cash flow, this is unlikely to continue.

Comcast Looks Like a Better Bet:

For investors looking to buy shares in an entertainment related company, there are better options than Time Warner. The company sells for about 13 times forward estimates and is expected to grow by about 11% over the next few years. While some investors might like the company's dividend yield of 2.5%, from the free cash flow numbers, this dividend doesn't seem as safe as some would think. If investors are looking for a higher yield, in time the best choice would seem to be Comcast. While the company's current yield of 1.9% is less than Time Warner, Comcast is only paying out about 14% of its free cash flow. With strong cash flow growth, expected earnings per share growth north of 14%, and such a low payout ratio, Comcast seems to be a much better option than Time Warner. Investors looking for more of a direct play on television properties would be well served to consider CBS Corp.

CBS and Walt Disney Look Better Too:

The company's CBS and Showtime properties, as well as their publishing and radio stations, generate significant cash flow as evidenced by their recent increase of their dividend and share repurchase programs. In addition, in a previous post I found that CBS offers the best combination of growth, cash flow generation, and balance sheet strength among the major networks. Walt Disney could also be an attractive option. The company's ABC and ESPN networks are strong competitors in their own right, and as we saw, the company studio segment may have the strongest lineup in the next year or so. If the economy continues to recover, the company's theme park performance should be strong as well. While the stock is not as cheap as some of its competition, the combined positive factors that Walt Disney offers may be worth the slight premium to their growth rate. As you can see, no matter where you turn there are better options than Time Warner.

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