Maybe It Truly Is Different This Time
It’s been said that the four most dangerous words in investing are “this time, it’s different.” The stock market’s behavior is clearly pointing to things being different this time.
In mid-day trading on Tuesday, shares of Chinese search engine company Baidu (BIDU) surged 10% (adding $5 billion in market value) on news that it is considering making its own electric vehicles. Private equity-backed Group Nine Media is exploring creating a SPAC (special purpose acquisition company, which raises money as a public company to buy as-of-yet-unnamed targets) to fund acquisitions of its competitors.
The initial public offering of in-vogue but likely never-to-be-profitable Airbnb (ABNB) was so successful that the company shot to a $101 billion valuation, more than the combined value of six of its largest publicly traded but decidedly more dowdy competitors including Marriott International, Intercontinental Hotels and Hilton Worldwide.
Each of these stories are but the latest examples of the market’s sublime confidence that the law of supply and demand, for the first time in economic history, has been repealed. That demand for electric vehicles, blind investment trusts, short-term apartment rentals/food delivery/marijuana farming tools and a myriad of other products and services will forever outstrip the available supply so as to ensure a vast and growing stream of profits and riches for investors.
We don’t doubt that the demand growth will be impressive, as there are strong new secular trends in place. Our doubt is on the supply side – that no new competition will emerge to crimp each company’s revenue share or (any) profits that might materialize. And, our doubt is also on the confidence side – the market’s firm conviction to price the shares such that the companies’ prosperous future is assumed to be guaranteed.
Maybe, this time it truly is different. Given the speculative fervor now building in the market, it almost needs to be different this time. On the “off chance” that this is just the market cycle repeating, we’re staying with our value-oriented focus.
Share prices in the table reflect Tuesday (December 15) closing prices. Please note that prices in the discussion below are based on mid-day December 15 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
No changes this week.
LAST WEEK’S PORTFOLIO CHANGES (December 9 letter)
Merck (MRK) – new Buy
Equitable Holdings (EQH) – from Buy to Hold
JetBlue (JBLU) – reducing price target to 19 from 20
GROWTH/INCOME PORTFOLIO
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.
Bristol raised its quarterly dividend by 9%, to $0.49/share from $0.45/share. On Tuesday, Goldman Sachs raised their rating on BMY to “Conviction Buy,” providing a tailwind to the shares.
BMY shares rose 1% in the past week. The shares have about 26% upside to our 78 price target.
The stock trades at a low 8.3x estimated 2021 earnings of $7.47 (up a cent from last week). With the dividend increase, BMY now has a 3.2% dividend yield. This dividend is well-covered by the company’s enormous 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 10th 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 roll-out, 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 manages 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, partly due to excessive overvaluation then. More recently, the shares reflect Cisco’s struggle in its core business 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 up 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. Cisco 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.
Cisco announced that it is now investing heavily in its Webex video service (a major competitor to Zoom) in an effort to capture more of this newly-important market. Although Webex has been around for well over a decade, its big-company focus has restrained its growth and market share. New features should help expand its appeal.
CSCO shares were flat in the past week and have about 24% upside to our 55 price target. The shares trade at a low 14.0x estimated FY2021 earnings of $3.16. This estimate was unchanged 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 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 1% in the past week. The stock has about 19% upside to our 64 price target.
While the valuation is not statistically cheap, at 25.4x estimated 2021 earnings of $2.11 and 23.0x estimated 2022 earnings of $2.33 (the 2022 estimate ticked up a cent 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 slipped about 2% this past week and have about 12% upside to our 60 price target.
The shares trade at 16.8x estimated 2022 earnings of $3.17, although this is two years away. This estimate increased fractionally 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.
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 the 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.
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.
There was no meaningful news on Merck in the past week.
Merck shares slipped about 3% this past week and have about 31% upside to our 105 price target.
MRK shares trade at an attractive 12.8x next year’s estimated earnings of $6.28.
The 3.2% dividend yield offers additional value for income-oriented investors. Merck produces generous free cash flow to fund this dividend as well as likely future dividend increases. BUY.
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 a 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.
Based on its good fourth quarter results, 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 recently 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.
There was no meaningful news on Tyson in the past week.
The shares rose 2% in the past week. The stock has 7% upside to our 75 price target.
TSN shares currently trades at 12.3x estimated 2021 earnings of $5.70. This estimate was unchanged this past week. Currently the stock offers a 2.5% dividend yield. While the stock has gained about 17% since June 30, and has about 7% upside remaining, we are retaining our BUY rating and revisiting our price target. 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 fell 3% this past week and have about 18% more upside to our 100 price target.
The shares trade at 22.9x 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, partly due to their high 8.6% dividend yield. Prospective investors should be aware that the shares represent a limited partnership interest, may produce K-1 taxable income, and have other tax implications. Our October 14th note has more color on AllianceBernstein.
While Equitable’s large variable annuities book may be vulnerable to market pullbacks, the company continues to slowly but steadily prove its stability and strength.
There was no meaningful news on the company this past week.
EQH shares slipped 5% in the past week and have about 10% upside to our 28 price target. Part of the price decline was likely due to the market sensitivity of EQH’s book value.
With the shares having risen 41% since the end of June, and are now approaching our 28 price target, last week we moved the shares to a HOLD. The valuation is no longer compelling at nearly 100% of tangible book value and 5.6x estimated 2020 earnings of $4.54 (unchanged in the past week). The shares offer an attractive 2.7% 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 another 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 exceeding Automotive debt again. GM Financial’s capital position remains sturdy.
Vehicle sales in China continue to show impressive strength. The China Association of Automobile Manufacturers trade group said that sales would be about 25.3 million units (both passenger and commercial), almost matching last year’s 25.8 million units. The group expects sales to climb 4% next year. GM has a sizeable business in China, so healthy growth in that market is a positive.
The United Auto Workers labor union agreed to independent oversight as part of a settlement in the wide-ranging corruption scandal that has led to convictions of former union officials. This may have implications for future labor negotiations with GM, although it’s not clear how, just yet.
GM shares fell 5% this past week, likely due to general investors worries about the pandemic. The shares have about 18% upside to our newly-raised 49 price target.
GM shares trade at 6.9x estimated 2021 earnings of $5.99. This estimate increased by about 1% 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 recently (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, bolstered by a recent equity raise (which led to us recuing our target to 19 from 20), gives it plenty of time to recover. The company’s 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.
This past week, several airlines followed JetBlue’s news by raising their estimates of their daily cash burn, reflecting the likely slowing of air travel as Covid cases surge.
JBLU shares fell 7% this past week and have 33% upside to our new 19 price target. Growing investor worries about the pandemic weighed on the shares.
The stock trades at 11.7x estimated 2022 earnings of $1.23 (this estimate fell by about 15% this past week and is volatile based on Covid case counts). 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 straight-forward – 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 3.0% 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 fell about 4% in the past week and have about 29% upside to our 59 price target.
The 2020 estimate ticked up a cent to $4.18. Estimates for 2021 to 2022 are unchanged at $4.17. The shares trade at 11.0x estimated earnings 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 8.2 current year 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. 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 5th. 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.
Last week, 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 slipped about 1% in the past week and have 15% 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 34.8x, 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 sub-par 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’s 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 declined about 5% this past week and have about 23% upside to our 43 price target.
ViacomCBS shares trade at about 8.2x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 8.1x estimated 2021 earnings of $4.30 (estimate down fractionally from a week ago). ViacomCBS shares offer a sustainable 2.8% dividend yield and look attractive here. BUY.
