Brian Wieser of the Pivotal Research Group is one of the savviest media analysts around. Here is his first quarter earnings report on Discovery Communications:
BOTTOM LINE: Discovery Communications reported results that we characterize as positive, if slightly below our expectations. The quarter still featured top-line improvements and reasons for optimism around overall progress in developing the cash-generating capacity and overall profitability of the business. We have updated our model and retained our $73 price target with a HOLD recommendation. Discovery is a standout business with attributes which are well-understood by investors, leading to a company with what we characterize as a generally fair, if often very highly valued stock. At current prices,Viacom remains our preferred stock in the sector given much more favorable cash yields (8% during 2014 on yesterday’s close for Viacom vs. 4% for Discovery on the same basis). Further, despite Discovery’s likely outperformance in revenue and cashflow generation over the next few years, even by 2017 Viacom will still be yielding more cash per share (10% by our estimates) than will Discovery (7%).
Highlights from the release and call include:
Total revenue was +4.8% vs. our +7.0%, although sources of difference were not overly meaningful in our view. We also note that results were in-line with consensus. Total US revenues were +0.7%. Inside of this growth, US distribution revenues were down by 8.6% vs our -6.3% (the prior year included 45mm in revenue from Amazon, making for difficult comparisons). Advertising revenue was up by 8.2% vs. our +10.0%, which we recently revised up following sequential improvements for most of Discovery’s competitors. Ad revenues grew slower for Discovery in 1Q13 vs. 4Q12, despite both periods having similarly difficult comps, but nonetheless 8.2% is still a solid growth rate.
International revenue trends matched or exceeded our expectations. International Distribution was +15.1% vs. our +15.0% and International Advertising was +22.6% vs. our +20.0%. Revenue growth of +16.8% was exactly in line with our forecasts, as incremental revenue from the acquisition of Italy’s Switchover, consolidation of Japanese assets and organic growth from Latin America (Brazil and Mexico in particular) as well as India and Russia all led to the result.
Looking forward, management maintained guidance for the year at $5.75-$5.7 billion in revenue. Guidance was maintained despite a delayed closing of acquisition of the SBS Nordic Assets, and guidance will likely be revised. For now, the company indicated it expects to fall inside of the current range, but not likely at the top-end. High single digit revenue growth is expected in 2Q13. Inside of the company’s forecasts are expectations for meaningful increases in distribution revenue in the US because of expected revenue from Netflix in 2Q or 3Q. As well, the company has highlighted robust expectations for the coming national TV upfront marketplace
Profitability should remain robust over the course of the year. Domestic adjusted OIBDA was light vs. our expectations at 55% of revenue vs. our 58% and international adjusted OIBDA only slightly below our expectations at 41% vs our 42%. Management noted that opex growth will remain in mid-teen range in next two quarters before meaningfully abating in 4Q. Relatedly, content spend growth should slow down leading to free cashflow growth for the year. OIBDA is still expected to come in at between $2.425bn and $2.525 billion for the year, as management previously guided. Net income to Discovery shareholders is expected to range between $1.2 billion and $1.3 billion. Our estimates come in at the bottom end of this range
RISKS. Investors in Discovery will need to be conscious of 1) the company’s reliance on a handful of core network brands which collectively account for small share of total TV viewing, 2) misguided perceptions by many investors and industry participants regarding the “death of TV advertising”, and 3) slowdowns in pay TV subscription levels or reduced ARPUs around the world may diminish growth in distribution fees for Discovery.