Should You Buy This Network?

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

When I discussed Scripps Networks Interactive (NYSE: SNI) in my first Fool post in April, the company’s shares were trading around $49.  At that time, Scripps’ shares had handily outperformed the S&P 500 after being spun off from E.W. Scripps in 2008.  Since then, things only got better as shares jumped by almost 30% to just under $64 in late October before settling to the recent price of around $60. This is a gain of more than 22% compared to less than 6% for the S&P 500 over that time span.  In the initial analysis, my intrinsic value calculation suggested a share price of $55 to $60, thus the shares are now fully valued as the market has begun to recognize Scripps’ competitive advantages and growth catalysts and to discount the company’s tremendous cash flow capacity.  The question now is, what can investors expect from the shares going forward.

In the earlier post, I described Scripps’ competitive advantages as pricing power with both its cable affiliates and its advertisers due to consistently high ratings, an advantageous cost structure relative to other types of higher cost programming, and strong brands derived from its on air personalities.  Furthermore, ongoing renewals of previously underpriced affiliate contracts and the emergence of telecom companies as content buyers were identified as long term catalysts for growing earnings and cash flow and continued share outperformance.  I think these competitive advantages and catalysts are still very much in place so my long term outlook for Scripps remains positive, but my intrinsic value estimate is unchanged at around $60 per share.

I expect to raise the price estimate as the company nears completion of several growth initiatives mentioned in the previous posting that are temporarily suppressing cash flow.  If these long term initiatives are executed successfully, Scripps’ permanent cash flow capacity will be expanded, cash flow will begin to grow again, and shares should rise accordingly.

Despite this long term bullishness, the short term may be less rosy than the past 6 months because of the strong share price gains and because of the temporarily reduced cash flow.  This reduction in cash flow, which amounted to 18.5% of  operating cash flow for the nine months ending September 30, is being driven by decreased margins from the company’s planned investments in growth initiatives including new domestic programming, international joint ventures, and streaming video on demand, or SVOD.

In addition to discounting cash flows to estimate the $55 to $60 share price, the previous post also compared Scripps to its two larger rivals, Disney (NYSE: DIS) and CBS (NYSE: CBS), in terms of projected growth and forward PE.  Back in April, Scripps’ price to earnings to growth (PEG) multiple for 2013 was 0.9x as analysts expected earnings growth of 17%.  This PEG ratio was in line with both Disney and CBS at 0.8x each.  Now, after the share price jump and revisions to EPS estimates, Scripps’ shares trade at a PEG multiple of 1.3x.  This compares unfavorably to Disney and CBS, which continue to trade in tandem at 0.9x each.  The gap in PEG between Scripps and its rivals has expanded from just 0.1x in April to 0.4x now which suggests limited upside for Scripps.

Going forward from the current $60 share price, capital gains from Scripps should be more difficult to capture than when I first looked at the company.  I am still strongly bullish on Scripps’ long term prospects because of its competitive position and growth catalysts, but on an absolute basis using discounted cash flows, Scripps’ shares are currently fully valued or perhaps even slightly overvalued.  Valuation analysis using PEG multiples confirms the decreased relative attractiveness of Scripps’ shares so I would wait for either a sizeable pullback in the share price to less than $55 or a resumption of positive cash flow growth before buying.  Given that the company’s growth initiatives currently crimping cash flow are part of a long term strategy, any buying opportunity is more likely to come from a broad market led decline in the next 12 to 18 months.  That would be an excellent time to buy.

56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney and Scripps Networks Interactive. Motley Fool newsletter services recommend Walt Disney and Scripps Networks Interactive. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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