What to do when there is nothing to do
Over the past month or so, it seemed like stocks would continue their frenetic surge. This week, however, the market appears relatively lackluster with a lot less excitement. Some investors may yearn for more fireworks, but as a value investor, I find this calm to be more sane. I value the time to think.
What does an investor do when there is “nothing” going on in the stock market?
Often, it’s a good time to revisit your basics, especially as the year-end approaches:
- How many positions do you hold compared to what you’d prefer? Setting a target for the number of your holdings allows you to actively think about this critical component of portfolio strategy. There is no magic number – but a general range of between 15-35 names is what most people find manageable.
- What are the sizes of your positions? If you use 25 stocks as your target holdings number, an average position will be 4%, so compare your largest and smallest positions to this average. If you find that you actually hold 35 stocks, with some 10% positions and several 0.5% positions, a rebalancing and name reduction might be useful.
- Which are your highest conviction names? These should be the stocks with the best risk/return trade-offs, yet still within your risk tolerance zone. If you really like a stock, add to it, and if that stale name that has limited upside is still in your portfolio, perhaps it’s time to let it go.
- With the year-end approaching, convert any losses in your taxable accounts into tax savings. While tax rates may change next year and each person’s tax situation is different, in general a loss can offset gains to save taxes. This is an under-appreciated way to keep more cash in your pocket rather than sending it to the IRS.
- Also, look at other markets: bonds, currencies, commodities, other equity markets. These can provide a broader context of the world beyond domestic equities, illuminating both opportunities and risks. And, there may not be a lot going on at the moment in the stock market, but other markets may be “busier.”
Another value of slow markets is finding new ideas. With this in mind, we are adding pharmaceutical maker Merck (MRK) to the Buy list. The company’s core business appears undervalued, and has an upcoming spin-off that should unlock additional value early next year.
Share prices in the table reflect Tuesday (December 8) closing prices. Please note that prices in the discussion below are based on mid-day December 8 prices.
Note to new subscribers: You can find additional color on each recommendation, their recent earnings and other related news in prior editions of the Cabot Undervalued Stocks Advisor on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
UPCOMING EARNINGS RELEASES
None in December.
THIS WEEK’S PORTFOLIO CHANGES
Merck (MRK) – new Buy
Equitable Holdings (EQH) – from Buy to Hold
JetBlue (JBLU) – reducing price target to 19 from 20
LAST WEEK’S PORTFOLIO CHANGES (November 18 letter)
Broadcom (AVGO) – from Hold to Sell
GROWTH/INCOME PORTFOLIO
New Buy: Merck (MRK) – With $47 billion in revenues, Merck is a major pharmaceutical company that focuses on oncology, vaccines, antibiotics and animal health. The company is among the many developing a Covid vaccine. Keytruda, a blockbuster oncology treatment representing about 30% of total revenues, holds an impressive franchise that is growing at a 20+% annual rate. The relatively new Lynparza and Lenvima cancer treatments offer considerable promise, as well. While Merck’s growth is currently driven by Keytruda, the company has a strong pipeline of upcoming products that should be additive to revenues and profits.
Merck also has a sizeable animal health business that generates about 10% of total sales. Revenues in this segment grew 9% in the most recent quarter.
The company’s third-quarter results were encouraging, with management raising their full-year revenue and earnings guidance.
To create more shareholder value, Merck is narrowing its strategic focus. In 2021, it will spin off its Women’s Health business, along with its biosimilars and various legacy brands. These segments currently generate roughly 15% of Merck’s total revenues yet comprise half of its product roster. Merck also recently divested its stake in Moderna, the producer of a promising Covid treatment. And, given the high valuations of other animal health businesses like Elanco and Zoetis, we would not be surprised to see Merck spin off or divest its animal health business in the future.
Merck’s financial condition is robust. Its $29 billion in debt is partly offset by $7 billion in cash and is readily serviceable by the company’s $17 billion in operating profits. The $0.65/share quarterly dividend is well-covered and provides an attractive 3.2% dividend yield.
Primary risks include its dependence on the Keytruda franchise, possible generic competition for its Januvia diabetes treatment starting in 2022, and the possibility of government price controls.
Merck shares trade at an attractive 13.1x next year’s earnings. Overall, Merck shares offer appealing upside. We are placing a 105 price target on Merck. BUY.
Bristol-Myers Squibb Company (BMY) is a New York-based global biopharmaceutical company. In November 2019, the company acquired Celgene for a total value of $80.3 billion, including $35.7 billion in cash and $40.4 billion in stock. We are looking for Bristol-Myers to return to overall revenue growth, both from resilience in their key franchises (Opdivo, Revlimid and Eliquis) and from new products currently in their pipeline. We also want to see the company execute on its $2.5 billion cost-cutting program, which will likely remain intact with the MyoKardia acquisition.
Like most biopharma companies, Bristol frequently issues news releases regarding its various treatments. Unless they meaningfully either strengthen or weaken our view on the company, we likely won’t comment on them here.
There was no meaningful news on the company this past week.
BMY shares fell 2% in the past week. The shares have about 27% upside to our 78 price target.
The stock trades at a low 8.2x estimated 2021 earnings of $7.46 (unchanged from last week). The 2.9% dividend yield is well covered by the company’s enormous $13.5 billion in free cash flow. BUY.
Broadcom, Inc. (AVGO) designs, develops and markets semiconductors that facilitate wireless communications. The company’s foundation is its #1 industry position in high performance RFIC (radio frequency integrated circuits), whose use in high-end smartphones has driven Broadcom’s growth and profits. About 25% of total revenues come from chips that go into high-end smartphones, with Apple providing about 20% of Broadcom’s total revenues. The company also provides software that runs technology infrastructure including telecom and corporate networks (about 28% of total revenue).
We moved Broadcom to a Sell on December 2, as the shares essentially reached our 410 price target. We see no imminent issues for the company, as it appears to be reasonably well positioned in the chip market. The company seems committed to and capable of paying its generous dividend.
However, we see some meaningful risks. Broadcom’s more recently acquired businesses, like CA (Computer Associates) and Symantec, may create a drag on growth as well as a limit on AVGO’s earnings multiple. Broadcom’s strategy of paying down excessive debt is great for value investors, but for the company to inspire growth investors it needs to show an ability to produce faster revenue growth. But the balance sheet may preclude deals big enough to accomplish that for at least the next year or perhaps more, and acquisition targets don’t appear to be cheap, either. The Apple exposure is a risk given that that company has discontinued using Intel’s chips in favor of its own, and we wonder if this strategy puts RFIC chips at risk eventually.
While estimates for 2021 show modestly respectable revenue (+8.4%) and earnings growth (+15%), estimates beyond that are lackluster (at 4% and 7%, respectively, for 2022). While the company’s earnings report on December 10 could drive growth estimates higher, the risk/return from a stock price perspective is unfavorable.
And, given the shares’ valuation on both an absolute basis and relative to its peers, we are similarly reluctant to raise the price target from here.
Where could we be wrong? If the company is able to leverage its other businesses to sell more chips, and if it becomes well positioned to benefit from 5G’s rollout, the shares could drive considerably higher.
AVGO shares produced a 31% total return (including dividends) from both the December 2019 initial recommendation and since June 30, 2020. SELL.
Cisco Systems (CSCO) is a $48 billion (revenues) technology equipment and services company. About 72% of revenues are from equipment sales, including gear that connects and manage data and communications networks, along with application software, security software and related services. Cisco provides a valuable one-stop-shop for its customers.
Cisco’s share price is now only about half its March 2000 peak. In recent years, the company’s core business has struggled against the rising adoption of cloud computing, which reduces the need for Cisco’s gear. Cisco’s prospects are starting to improve, with CEO Chuck Robbins in the CEO seat (since 2015), starting a slow but steady process to reinvigorate its operations. An impressive new CFO joined in December 2020.
Cisco is shifting its business mix to a software and subscription model and ramping new products, helped by its strong reputation and its entrenched position within its customers’ infrastructure. As long as it can stay close enough to competitors’ offerings, the company should retain these valuable intangible assets. The company has its challenges, including convincing investors that it can successfully navigate the secular changes in technology gear demand, along with overcoming near-term signing delays due to the pandemic.
The company is highly profitable and generates vast cash flow, which it returns to shareholders through its dividend and share buybacks. The balance sheet carries $30 billion in cash, double the $14.6 billion in total debt.
Interested investors might want to tune into the company’s annual shareholder meeting, to be held on December 10 at 11 a.m. ET. The link to listen is here.
Cisco announced that it will acquire U.K.-based IMImobile for $730 million (cash), which brings cloud-based communications software and services to help companies stay better connected to its customers.
CSCO shares rose 3% in the past week, and have about 25% upside to our 55 price target. The shares trade at a low 14.0x estimated FY2021 earnings of $3.16. This estimate rose fractionally in the past week. On an EV/EBITDA basis, the shares trade at a discounted 9.7x multiple. BUY.
Coca-Cola (KO) is best known for its iconic soft drinks yet also has a strong portfolio of non-soda brands, including PowerAde, Fuze Tea, Glaceau, Dasani, Minute Maid and Schweppes. Nearly 40% of its revenues now come from non-soda products across the non-alcoholic spectrum, including juice/dairy/plant beverages, water/hydration drinks, tea and coffee, and energy drinks. Its vast and deep global distribution system offers it the capability of reaching essentially every human on the planet.
Relatively new CEO James Quincey (2017) is a highly-regarded company veteran with a track record of producing profit growth and making successful acquisitions. To improve its global operations, Coca-Cola is reorganizing to become more effective and more efficient, refocusing its innovation efforts and culling its portfolio of over 400 brands by 50% to focus on its highest-priority offerings. Coke is also centralizing and standardizing back-office administrative services. The company is working to improve its image (and reality) of selling sugar-intensive beverages that are packaged in environmentally-insensitive plastic.
While the near-term outlook is clouded by pandemic-related stay-at-home restrictions, the secular trend away from sugary sodas, high exposure to foreign currencies and always-aggressive competition, the longer-term picture looks bright.
Coca-Cola’s sturdy balance sheet carries $53 billion in debt that is well covered by cash flow and partly offset by over $21 billion in cash. The $0.41/share quarterly dividend is also well covered by solid free cash flow.
There was no meaningful news on the company this past week.
KO shares rose 3% in the past week. The stock has about 21% upside to our 64 price target.
While the valuation is not statistically cheap, at 25.1x 2021 estimated earnings of $1.89 and 22.8x estimated 2021 earnings of $2.11 (both unchanged in the past week), they are undervalued while also offering an attractive 3.1% dividend yield. BUY.
Dow Inc. (DOW) merged with DuPont in 2017 to temporarily create DowDuPont, then split into three parts in 2019 based on the newly combined product lines. Today, Dow is the world’s largest producer of ethylene/polyethylene, the world’s most widely-used plastics. Dow is primarily a cash-flow story driven by three forces: 1) petrochemical prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume of chemicals sold, largely driven by global economic conditions; and 3) ongoing efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).
Dow’s third-quarter earnings report was encouraging and the company is making progress with its strategic goals.
There was no meaningful news on Dow in the past week.
Dow shares rose about 1% and have about 12% upside to our 60 price target.
The shares trade at 17.0x estimated 2022 earnings of $3.16, although this is two years away. This estimate was unchanged this past week.
Valuation on estimated 2020 earnings of $1.40 is less meaningful as this assumes no recovery.
The high 5.2% dividend yield is particularly appealing for income-oriented investors. Dow currently is more than covering its dividend and management makes a convincing case that it will be sustained. However, there is a small risk of a cut if the economic and commodity recoveries unravel. HOLD.
Tyson Foods (TSN) is one of the world’s largest food companies, with over $42 billion in revenues last year. Beef products generate about 36% of total revenues, while chicken (31%), pork (10%), and prepared/other contribute the remaining revenues. It has the #1 domestic position in beef and chicken with roughly 21% market share in each. Its well-known brands include Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright and Aidells. Tyson’s long-term growth strategy is to participate in the growing global demand for protein. The company has more work to do to convince investors that the future is brighter, particularly as it is more of a commodity company (and hence has lower margins) compared to its food processor peers.
Tyson reported good fourth-quarter results, although chicken prices remain weak. Tyson’s fourth-quarter guidance pointed toward continued but moderate improvements. Overall, it looks like Tyson’s annual earnings power is around $6.25/share, better than the $5.64 for fiscal 2020 and higher than most pre-Covid years. The company raised its dividend by 6% to $0.445 per quarter. Tyson’s recovery will remain volatile from quarter to quarter but is on the right track.
Beef competitor JBS is temporarily sending home (with pay) hundreds of workers who are at an elevated risk of serious health problems if they contract Covid, an expensive but humanitarian move that may be replicated by Tyson.
Tyson and 16 other chicken producers were sued by fast food restaurant company Chick-Fil-A and (separately) by Target Stores, for artificially raising prices on chicken products, adding fuel to the smoldering scandal. It is now unclear how deeply this issue will affect Tyson, but it will likely remain at least a mild overhang on the shares.
The shares rose 5% in the past week. The stock has 10% upside to our 75 price target.
TSN shares currently trade at 12.0x estimated 2021 earnings of $5.70. This estimate ticked up fractionally in the past week. The 2022 estimate rose by a nickel – tiny but in the right direction. Currently the stock offers a 2.6% dividend yield. BUY.
BUY LOW OPPORTUNITIES PORTFOLIO
Columbia Sportswear (COLM) produces the highly recognizable Columbia brand outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware, and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm.
After a disappointing third quarter, after which the stock fell sharply, as price-sensitive investors we raised COLM shares back to a Buy. We think the company low-balled its guidance, with its long-term earnings power impeded but pushed out into the future. It also announced personnel changes in several key operational roles. Columbia’s balance sheet remained solid.
There was no meaningful news on the company this past week.
Columbia’s shares rose 6% this past week and have about 15% more upside to our 100 price target.
The shares trade at 23.5x estimated 2021 earnings of $3.71. The earnings estimate is unchanged from last week. For comparison, the company earned $4.83/share in 2019. BUY.
Equitable Holdings (EQH) owns two principal businesses: Equitable Financial Life Insurance Co. and a majority (65%) stake in AllianceBernstein Holdings L.P. (AB), a highly respected investment management and research firm. Acquired by French insurer AXA in 1992, Equitable began its return to independence with its 2018 initial public offering as part of a spinoff. AXA currently owns less than 10% of Equitable. With its newfound independence, Equitable is free to pursue new opportunities.
The company is well capitalized and has significant liquidity. It continues to de-risk and de-capitalize its balance sheet, most recently with its agreement to transfer the risk on $12 billion of variable annuities to a third party. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. Equitable’s lower capital requirements is helping it continue its share repurchase program. The company is targeting a 50-60% of earnings payout ratio in the form of combined dividends and share repurchases.
AllianceBernstein shares (AB) are modestly attractive in their own right. Our October 14 note has more color on AllianceBernstein.
Equitable’s third-quarter results were good, and the company added to its excess capital and liquidity base. Overall, while its large variable annuities book may be vulnerable to market pullbacks, the company continues to slowly but steadily prove its stability and strength. Book value per share, excluding intangibles, fell 7% to $26.63. Book value including intangibles rose 32% to $36.05.
There was no meaningful news on the company this past week.
EQH shares rose 4% in the past week and have about 6% upside to our 28 price target.
With the shares having risen 41% since the end of June, and now approaching our 28 price target, we are moving the shares to a HOLD. The valuation is no longer compelling at 100% of tangible book value and 5.8x estimated 2020 earnings of $4.54 (unchanged in the past week). The shares offer a 2.6% dividend yield. HOLD.
General Motors (GM) under CEO Mary Barra (since 2014) has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. We would say it is perhaps 75% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the very early stages of its EV development. Its GM Financial operations are well-capitalized but may be tested as the pandemic unfolds. Near-term, the shares will trade based on progress with a federal stimulus plan, the pandemic, the general U.S. economic outlook, trends in light vehicle sales, its progress with alternative vehicles and of course its earnings.
GM produced a remarkable third quarter, with adjusted earnings increasing 65% from a year ago and nearly double the $1.43 consensus estimate. From a different perspective, the company’s revenues were the same as a year ago, but the $5.3 billion in adjusted operating profits was $2.3 billion, or 78%, higher. Its outlook is for a strong 2021, with perhaps a return to the $6.50 earnings per share range that it would otherwise have earned this year. GM’s balance sheet is sturdy, with Automotive segment cash exceeds Automotive debt again. GM Financial’s capital position remains sturdy.
Surprisingly, there was no meaningful news on GM this week.
GM shares were unchanged this past week although they have slipped back about 6% from their recent high. The shares have about 12% upside to our newly-raised 49 price target.
GM shares trade at 7.4x estimated 2021 earnings of $5.91. This estimate increased by a cent this past week. HOLD.
JetBlue Airlines (JBLU) is a low-cost airlines company. Started in 1999 from JFK Airport in New York City, the company has grown to now serve nearly 100 destinations in the United States, the Caribbean and Latin America. The company’s revenues of $8.1 billion last year compared to about $45 billion for legacy carriers like United, American and Delta, and were about a third the revenues of Southwest Airlines ($22 billion).
Its low fares and high customer service ratings (with among the highest customer satisfaction ratings in the industry) have built a strong brand loyalty. Low costs, including its point-to-point route structure, have helped JetBlue produce high margins in prior years, particularly relative to the legacy carriers. Its TrueBlue mileage awards program is a recurring source of revenues, as it sells miles to credit card issuers.
The pandemic has sent JetBlue, and the entire industry, into a near-term depression. Its available seat miles (ASM – a measure of how may seats an airline flies) were only 42% of its year-ago level. Like its peers, JetBlue parked many of its jets, flew others less-frequently, and took middle seats off the market. On its in-service planes, it filled less than half of its available seats with passengers in the third quarter, further weighing on revenues which fell 76% in the quarter.
To help reduce its $6 million/day cash burn (cash outflows from operating losses and capital spending), JetBlue is aggressively cutting its costs. Also, per-gallon fuel prices are 40% cheaper than a year ago, easing what typically is its second-highest expense.
We think consumers are increasingly likely to return to flying. Good news on a Covid vaccine, the continued economic recovery, and pent-up demand are starting to bring back passengers, particularly the leisure traveler. Business travelers are more likely to be slower to return to air travel. Your chief analyst is one such leisure travel venturer, flying non-stop from Boston to San Diego last week (full disclosure: on JetBlue) with no Covid issues. JetBlue’s route base and customer profile make it likely to be among the first to see a step-up in traffic.
JetBlue’s cash balance of $3.6 billion gives it plenty of time to recover, given its shrinking cash burn, although its debt is somewhat elevated at $4.8 billion. While JBLU shares have jumped recently, and near-term it remains vulnerable to rising quarantine risks in the Northeast, its longer-term outlook is promising.
The shares carry more than the usual amount of risk, given uncertainties from the pandemic, fuel costs, labor issues, the ever-present risk of irrational competition and the overall economy.
After the market closed on December 1, JetBlue raised about $507 million through an equity offering of 35 million shares at $14.40/share. The issue was a bit of a surprise, and JBLU stock fell to the offering price in next-day trading but quickly recovered. Currently equity holders will be diluted by about 11-12% but the reduced risk that the new cash brings offsets much of that dilution. We reduce our price target to 19 from 20 to reflect this effect.
JBLU shares rose about 2% this past week and have 24% upside to our new 19 price target.
The stock trades at 10.6x estimated 2022 earnings of $1.45 (this estimate jumped about 26% this past week). On an EV/EBITDA basis, the shares trade at 5.5x estimated 2022 EBITDA. BUY.
Molson Coors Beverage Company (TAP) – The thesis for this company is straightforward – a reasonably stable company whose shares sell at a highly discounted price. One of the world’s largest beverage companies, Molson Coors produces the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its $10 billion in net revenues are produced in the United States, where it holds a 24% share of the beer market.
Investors’ primary worry about Molson Coors is its lack of meaningful (or any) revenue growth as it has relatively few of the fast-growing hard seltzers and other trendier beverages in its product portfolio. Our view is that the company’s revenues are resilient, it produces generous cash flow and is reducing its debt, traits that are value-accretive and underpriced by the market. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products.
We anticipate that the company will resume paying a dividend mid-next year, perhaps at a $0.35/share quarterly rate, which would provide a generous 2.9% yield.
Molson Coors recent results showed that the company is making progress with its turnaround and that investors underestimate this progress.
There was no meaningful news related to Molson Coors this past week.
TAP shares rose about 5% in the past week and have about 22% upside to our 59 price target.
Consensus estimates did not change in the past week. Estimates for each year from 2020 to 2022 are currently $4.17, so, the shares trade at 11.6x this estimate for all three years. These valuations are low, although not the stunning bargain from a few months ago.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.5x estimates, among the lowest valuations in the consumer staples group and well below other brewing companies.
For investors looking for a stable company trading at a low valuation, TAP shares continue to have contrarian appeal. Patience is the key with Molson Coors shares. We think the value is solid, although it might take a year or two to be fully recognized by the market. BUY.
Terminix Global Holdings (TMX) is both a new company and an old company. While the name “Terminix” is one of the largest and most widely recognized names in pest control, the company previously was obscured inside of the ServiceMaster conglomerate. With the sale of its ServiceMaster Brands operations recently completed, the company changed its name to Terminix and started trading under the TMX ticker symbol on October 5. The divestiture cleans up the company’s balance sheet. Terminix appears to have fully addressed its legal liability from deficient termite treatments, removing an overhang on its shares. A new CEO, Brett Ponton, former head of Monro (MNRO), joined in August. His leadership at Monro led to sales growth and a strong recovery in its share price. Our expectation is that he will bring sales growth, operational efficiency and integrity to Terminix, ultimately leading to a higher share price.
Terminix reported third-quarter adjusted per share earnings of $0.26, on revenues of $512 million. Revenues increased 10% from a year ago, with residential revenues increased 4% while commercial revenues fell 3%. Acquired franchises and European franchises provided growth as well. Adjusted EBITDA of $98 million was healthy. Unusual expenses totaling $52 million weighed on the quarter, but likely won’t hold back future results.
The company announced that the CFO will be retiring early next year. We have a mixed view on this. We’re fine with the new CEO bringing in his own team. The outgoing CFO joined in 2017 and supported the company through sizeable financial and strategic transitions and controversies. The incoming CFO brings considerable experience but his three prior companies filed for bankruptcy so we’re not entirely clear what the appeal is. Net, we’d say this was a modest negative to the story.
Terminix shares rose about 3% in the past week and have 13% remaining upside to our 57 price target.
Reliable consensus 2022 earnings estimates appear to be settling at around $1.43/share, about 11% below our initial estimate. This would put the TMX multiple at a high 38.3x, but we recognize that these types of companies generally are valued on EV/EBITDA. On this basis, the shares trade at about 17.6x EBITDA.
Major risks include the possibility of new disclosures that would significantly increase the company’s litigation expenses, difficult industry competition that may exert pricing pressure, and possible execution risks by the new leadership. TMX shares carry more risk than typical CUSA stocks, but if its litigation and subpar margins are behind them, we see a clear path to a higher stock price.
With a reasonable valuation, solid balance sheet, renewed focus and better revenue and margin outlook, there is a lot to like about Terminix. BUY.
ViacomCBS (VIAC) is a major media and entertainment company, owning highly recognized properties including Nickelodeon, Comedy Central, MTV and BET, the Paramount movie studios, Showtime and all of the CBS-related media assets. The company’s brands are powerful and enduring, typically holding the #1 market shares in the highest-valued demographic groups in the country. ViacomCBS’ reach extends into 180 countries around the world. Viacom and CBS re-merged in late 2019 and are now under the capable leadership of former Viacom CEO Robert Bakish.
Viacom is being overhauled to stabilize its revenues, boost its relevancy for current/future viewing habits and improve its free cash flow. Its challenges include the steady secular shift away from cable TV subscriptions, which is pressuring advertising and subscription revenues. The pandemic-related reductions in major sports are also weighing on VIAC shares. However, ViacomCBS’ extensive reach, strong market position and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.
As part of its overhaul, Viacom is shifting away from advertising (currently about 36% of revenues) and affiliate fees (currently about 39% of revenues), toward content licensing – essentially renting its vast library of movies, TV shows and other content to third-party firms like Netflix and others. Viacom is building out its own streaming channel (Paramount+) and other new distribution channels, which are generally showing fast growth. Ultimately, we think the company may be acquired by a major competitor, given its valuable businesses and content library, as well as its bite-sized market cap of about $20 billion.
Viacom reported a reasonably good third quarter, with revenues and profits down year-over-year but ahead of estimates. It generated $1.4 billion in operating cash flow and $1.3 billion in free cash flow. The cost-cutting program is well-underway and boosting cash flow. However, cash flow ultimately needs to be higher. So far this year, ViacomCBS has reduced its debt net of cash by about $1.5 billion, or 8%. Cash remains robust at $3 billion.
There was no meaningful news this week related to the company.
VIAC shares rose about 5% this past week and have about 16% upside to our 43 price target.
ViacomCBS shares trade at about 8.4x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 8.6x estimated 2021 earnings of $4.31 (estimate unchanged from a week ago). ViacomCBS shares offer a sustainable 2.6% dividend yield and look attractive here. BUY.
