Disregard The Bears, Buy These 3 Media Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While there has been abundant commentary about the market being overvalued, the S&P 500 still trades at 15.8x - not much higher than the 15.5x historical average. It is still true that the macroeconomy is uncertain right now. Given such a climate, I recommend holding a portion of your investments in safe brand companies that have less correlation to macro trends. Media is one sector that will "do its thing" largely irrespective of the economy. In this article, I will review the fundamentals of Sirius, Viacom, and CBS.
Sirius XM (NASDAQ: SIRI)
For a firm that has a treasure trove of net operating losses to shelter future taxable income, Sirius surprisingly receives a good deal of criticism on the Street. Its high multiples of 30.7x and 19.6x on a PE and forward basis, respectively, are typical targets. But the bears fail to appreciate that the company is forecasted for 22.6% annual EPS growth over the next five years.
The satellite radio broadcaster recently announced that it was redeeming 9.75% Senior Secured notes maturing 2015 in September. I believe this will allow the firm to have a reasonable debt level while beginning to buy back shares. Leverage will drive high free cash flow growth, which is estimated to gain 30% this year by Piper Jaffray. At the same time, subscriber growth continues to rise and the recent pricing change is unlikely, in my view, to cause meaningful churn.
Some bears have argued that competition is intense in music. Pandora (NYSE: P) and Sirius, however, can coexist. Both firms attract two different markets: the former seeks music listeners; Sirius includes more auto conversational radio. The latter's ability to retain top talent, like Howard Stern, is a testament to its sustainable brand power. Liberty Media is employing a reverse Morris Trust structure to efficiently distribute Sirius returns to its own shareholders. There is substantial overhang from negative perceptions about this being malicious to non-Liberty Sirius shareholders, and according to Piper Jaffray, that overhang will be mitigated when the various filings slow.
Viacom (NASDAQ: VIAB)
Viacom may be one of the less popular media stocks, but it is trading at exceptionally low multiples as a result. It is valued at a respective 11.3x and 9.4x past and forward earnings. Moreover, the PEG ratio currently stands at 0.74, which indicates that future growth has not been fully factored into the stock price. When complemented by a 2.4% dividend yield and growing free cash flow, Viacom is an under-appreciated business. The $24.4B firm generated $2.5B in free cash flow last year, which means less than a 10x multiple.
If the company meets analyst forecasts for annual EPS growth of 15.28% over the next five years, it will realize 2016 EPS of around $7.57. At a 15x multiple, the firm's future stock value will be $113.55. Now, Viacom is currently worth $46.23 per share. If you discount my future stock projection back by 10%, the present value should be $70.51. This means that there is more than a 50% margin of safety that the stock will more than double in value over the next half decade. In fact, it would take around a 20% discount rate at my future stock projection to justify Viacom's current stock price. Viewership declines have been overblown - simply too much doubt and negativity is being factored into the company.
Management is pushing for margins north of 20% in 2013 and a compounded EBIT growth rate of 30% over the next 5 years. During the second quarter earnings call, management stated that is solidly on track to realizing its goal. Quarterly EPS growth y-o-y has taken off like a rocket - gaining 71.4% against the 24% industry average. Accordingly, I recommend buy shares in this irrationally beaten down stock.
CBS (NYSE: CBS)
To get a sense of how undervalued Viacom is, look at CBS. CBS currently trades at a respective 15.4x and 11.7x past and forward earnings despite a lower growth forecast. Analysts anticipate that the stock will generate annual EPS growth of 13.8% over the next 5 years. Moreover, the dividend yield is around 100 bps lower. With that said, based on data from FINVIZ.com, those same analysts prefer CBS over Viacom.
Part of the attraction to CBS comes from its reputation for high ratings and sustainability. In yet another move to cement itself as the "safe media stock", CBS recently announced that it would be increasing its share repurchase program by $1.7B to $4.7B while also increasing the dividend distribution 20% to $0.12/share. The company has since risen 6.3% off of the news. While this move returns free cash flow to shareholders, it also showcases management's confidence over the advertising market. By contrast, the bears will have you believe that volatility in advertising would prevent outperformance while an economic downturn would warrant more financial stringency.
There are several underlying growth drivers that will lead to strong appreciation. With political advertising coming in, CBS should also receive a nice boon in the third quarter. I am also optimistic about online video licensing business, which will come from growth in providers like Amazon, Netflix, and Hulu. The growth of this segment will also expand margins. Retransmission fees are trending upwards from less than $300M in 2012 to nearly $1B in 2017. The absence of additional debt should lead CBS to generating 20% FCF/share growth over the next few years - hitting $4.50 in 2015. Deleveraging further will lead to abnormally high returns on invested capital.
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