- Time Warner continues to execute on its guidance, which has been well received by analysts.
- While there are risks to sustained affiliate revenue growth, much of these risks could be overstated.
- I believe Time Warner stock is fairly undervalued and should be bought on pull backs.
Time Warner Inc. (NYSE:TWX) continues to surprise with sheer consistency, as I wasn’t anticipating the company to deliver such great execution on costs in the prior quarter. While the company hasn’t developed sizable momentum with HBO Now (streaming application), the efforts in affiliate fees and advertising were enough to mitigate some of my concerns. I guess, I continue to favor Time Warner and Walt-Disney in this environment, and while many are trying to steer clear of conventional media, I view these two companies as stalwarts regardless of environment or eventual transition to full digital over broadcast/cable.
Here’s why I like Time Warner:
- Sustained growth in an environment of slimming TV bundles (maintained guidance of 12.6% EPS growth).
- Resilience in core franchises like TNT, CNN, HBO and Cartoon Network.
- Strong movie slate with Fantastic Beasts and Where to Find Them and Batman v Superman likely to gross over $1B+ internationally (each).
- Relatively reasonable valuation (15.7x earnings and 2x sales).
- Enough diversification in the form of movies and online streaming platforms to sustain reasonable earnings/sales even if audience shifts to digital streaming.
Given the maintained earnings outlook and relatively strong results across advertising and affiliate fees, it remains one of the better plays in the space. The company is growing sales at a quicker pace than its increasing expenses, so we’re finally starting to witness some expense leverage as the business already operates at incredible scale. Furthermore, investments into reliable franchises and on-going election coverage via its CNN news channel has bolstered results. It’s not yet clear whether affiliate revenue growth is sustainable once we move past the general election, but I feel fairly confident that with an even stronger movie slate for 2017, the company can adjust for lumpiness in cable revenue following what has been a relatively eventful election cycle.
Analysts were mostly upbeat and many have estimates that are higher than management’s current outlook:
On reaffirmed 2016 EPS guide ($5.30-5.40), our 2016/17E EPS goes to $5.39/$6.10 from $5.36/$6.08. TWX still expects adj. EBIT growth to be 2Hweighted. FY guide assumes reduced f/x drag ($0.10 vs. prior $0.15), primarily at Turner and Warner Bros. We estimate core domestic ad growth is pacing up MSD for 2Q (with total ad growth outlook of MSD-HSD reflecting NCAA finals pick-up), vs. MSD for 1Q. For 2016, our Turner growth estimates go to 5% from 4% for advertising, stay 12% for subscription revenue (domestic outlook is still for low teens growth), and go to 10% from 9% for adj. EBIT. Our HBO growth estimates\ remain 9% for subscription revenue, and go to 7% from 10% for EBIT growth. Our Warner’s EBIT estimate remains $1.55bn. – James Dix from Wedbush Securities
The $0.20 beat + a $0.05 lower than expected FX drag for the year leaves questions around why EPS guidance wasn't raised. We think management is staying conservative vs seeing any incremental weakness in the remainder of the year. We think the conservatism is affected by 3 primary drivers: 1.) TV licensing at Warner Bros. was strong in Q1 and may be a pull-forward; 2.) timing of Turner programming expenses (+4% y/y in Q1) suggests acceleration from here; and 3.) 2016 is a big investment year with TNT programming and HBO NOW, so management now has some buffer on these costs. We think consensus will come up by ~$0.05 to at least price in the weakening US dollar. we maintain our target CY16/17 P/E of 16.0x (10.8x EV/EBITDA) and think TWX has rerating potential. This results in a target price of $92 and justifies our continued Outperform rating. – Steven Cahall from RBC Capital Markets
The current consensus estimate is $5.38, which sits at the high end of the management's outlook for 2016 ($5.30 to $5.40 EPS). At this point, there’s some variance to earnings result due to F/X, but with headwinds relatively muted, it’s likely that Time Warner will report a modest beat for FY’16.
Advertising trends were relatively healthy despite the recent reduction in TNT network ad inventory. In either case, TWX isn’t that dependent on advertising revenue, which puts it in a relatively solid position to bounce back once agency spend recovers for conventional TV timeslots.
I’m also anticipating Time Warner to report at the high-end this year, and among media peers, it remains perhaps the best insulated from weakening subscription revenues ironically. The partial dependence on sport broadcast played out favorably for Time Warner, and with TNT’s on-going coverage of the NBA finals, it’s likely that seasonal lift will play a role in TWX’s next quarterly earnings as ratings are expected to be strong for much of the Western Conference playoff series.
Recent efforts are promising, but delivering upon a more complete mobile app/bundled product would be desirable. With less and less revenue coming from conventional subscriptions it’s noteworthy that Time Warner was able to maintain affiliate fee growth. However, broad secular decline still entails the same risks for peers as it does for TWX, so the real key is whether core franchises can transition to a licensing or direct to consumer model. Given Time Warner's quality portfolio, and initial efforts on direct to consumer via a mobile app, there’s a narrow enough silver lining in the management’s long-term playbook worth hanging our hat on.
I’m maintaining my buy recommendation and initiating a price target of $88.45 (16.38x FY’16 EPS) on Time Warner stock. I believe the stock will experience some mean value reversion over the next couple months as investors have overly priced in “known risks.” I believe that a steady pattern of execution and on-going efforts to diversify revenue streams will overcome the wall of worry among the investor base. In other words, there’s nothing truly innovative or novel about the business model, but we know that it still works. So as long as Time Warner is able to pivot to more digital based revenue when the time comes, the stock should exhibit fairly reasonable returns over the next several years.