Plenty of Upside to Estimates and Stock Price at CBS

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CBS reported slightly better than expected 4Q10 results, no small feat given rapidly rising estimates and a surging stock price. Adjusted EPS of 46 cents beat the street consensus of 44 cents. Revenues of $3.9 billion exceeded consensus by about $50 million. EBITDA was better than expected at the segment level, driven by beats at radio and TV stations, Showtime, and Outdoor.
CBS does not provide guidance but commentary about strength in advertising continuing in 1Q and set up for strength throughout 2011 is encouraging. In addition, management reiterated excellent expense control in 2011. The only flaw I see is that management stated that 1Q11 revenues would be down year over year due to last year’s Super Bowl broadcast and sharing March Madness revenue with Turner. Consensus is for flat revenue. However, management reiterated that margins would expand considerably and profits would grow despite the down revenues. Consensus EBITDA is 1Q is $436 million, up from $300 million a year ago despite the lower revenues.
Les Moonves opened the call by stating the EBITDA margins in 2011 should at least match the 19.7% reported in 4Q10. Right now, consensus calls for an EBITDA margin of just 18.4%. In addition, given advertising strength and a perfect setup for the May upfront, revenue estimates for 2011 are likely too low despite the down 1Q. In other words, estimates for 2011 are going higher. I expected this given the benefits of a stable primetime schedule, the new NCAA basketball contract, the new retransmission deal with Comcast, new movie contracts at Showtime, and good management of expenses.
Maybe more bullish was Moonves stating that CBS can exceed peak margins within “a couple of years.” In 2007, pre-recession, CBS had an EBITDA margin of 22%. If a couple of years means 2012, then estimates for next year are way too low as current consensus is for a margin of 19.4%. Keep in mind that 2012 is going to be mega year for political, something not widely discussed quite yet.
On the risk front, investors will worry if the NFL does not play next season. This would likely pressure CBS shares but Moonves indicated that the contract has protection built in so that it is a timing issue rather than a forever lost profits issue. And ratings are always a risk. Right now, CBS is enjoying ratings at least as good it promised advertisers. But the fall of 2011 is another season and some of the long-time hits at CBS are aging.
With estimates headed materially higher for 2011 and 2012, free cash flow exploding, a great management team, and a commitment to return cash to shareholders, CBS shares remain very attractive despite the huge run over the past two years.
Disclosure: Disclosure: CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. CBS is a net long position in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, owns a stake in the Funds’ investment management company, and has personal monies invested in the Funds.

OK Quarter and Good Guidance for Discovery Communications

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Discovery Communications (DISCK/DISCA) reported 4Q10 results largely inline with expectations. Revenue and EBITDA grew 7% and 16%, respectively. There were a few warts in the report. Domestic advertising came in 100-200 basis points below reduced expectations as ratings weakness in 4Q took a toll. Domestic growth of 13% is still nothing to sneeze at although relative to some peers that saw accelerating growth in 4Q (Disney, Time Warner), DISCK did fall back in the pack somewhat. The other weakness was in international where advertising growth and margins came in under expectations due to tough comps and expense growth to support channel rollouts.
The domestic shortfall looks like it has already cleared up as ratings have rebounded so far in 2011. This should allow advertising to accelerate in 1Q11. In fact, management guidance for 2011 advertising growth appears ahead of the street at about 10%. I think guidance may still be low, especially if ratings hold. The upfront should be very strong and 1Q will grow well ahead of guidance. Comps stiffen as the year goes by, however.
One new issue that came up on the DISCK call and other conference calls from cable network owners is decelerating domestic affiliate fee growth related to declining multichannel subscribers. DISCK management was confident that this situation has stabilized based on its latest numbers. Cable and satellite companies report this week so we should have a better idea. This is something that bears watching, however, as the cable network growth story has been fueled by both affiliate fees and advertising. Losing one leg as advertising comps stiffen due to cyclical issues would not be ideal for longs.
Another issue facing DISCK is a slow start at OWN, Oprah Winfrey’s network. DISCK is investing another $50 million, bringing total investment to $239 million. Management is still forecasting breakeven EBITDA in 2011 but poor ratings and increased investment is not a positive sign. The street is likely to give the company the benefit of the doubt until Oprah’s broadcast show ends in the fall and more new programming, including Oprah herself, appears on OWN. The buyside is more concerned. I think the network is worth north of DISCK’s investment even with the low ratings.
The Hub, the kid’s network partnership with Hasbro, is off to a better start. Combined the two networks swing from meaningful losses in 2010 to at least breakeven in 2011, providing a nice boost to growth this year. This is particularly evident in EPS, where management issued guidance well above the street.
One piece of very good news in DISCK’s report was acceleration in share buybacks in January and early February. Away from a one-time buyout of part of an insider’s holding, DISCK’s buyback activity had been disappointing. The increased pace is helping to close the gap between DISCK and DISCA shares as management has been buying the lower priced DISCK shares.
I remain positive on DISCK despite the premium valuation. A superior business model driven by high margin non-fiction programming that easily translates internationally warrants a premium valuation. I can see upside in DISCK shares to the high $40s if ratings hold and the economic recovery continues providing support for domestic advertising.
Disclosure: DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. DISCK, TWX, and DIS are net long positions in the Entermedia funds. DISCA and DISCK are a short/long spread trade in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, owns a stake in the Funds’ investment management company, and has personal monies invested in the Funds.

Mid Cap and Value Still Favored for February

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There were no changes to Northlake’s Market Cap and Style model signals for February. The Market Cap model continues to favor mid cap, while the Style model still recommends value. As a result of the latest signals, Northlake clients will maintain positions in the S&P 400 Mid Cap (MDY) and the Russell 1000 Value (IWD).
Underlying movement in both models was minimal. The mid cap signal did weaken slightly and is not far off a switch to large cap. Recent weakening in the dollar as the European crisis eased moved the U.S. Dollar indicator in favor of large caps. The rest of the Market Cap model indicators remained unchanged for February.
Since a strong small cap signal in November, the Market Cap model has shifted steadily toward large cap. The message is that the economic recovery is moving into a more normal phase of sustained growth. As a result, it no longer pays to own the riskiest of the three asset classes (small, mid, and large cap equities). It is counterintuitive but it is usually best to own the risky asset at extremes. As the extreme, reversion to the mean, or the risk trade, pays off. Now that economic risk has receded, as recent data shows steady strengthening, the model is moving to safer investments since the incremental upside in risky investments is less.
The Style model shifted to growth for one month back in November but is now firmly in value territory again. That makes nineteen of the last twenty months where value was favored. Value is favored when the economy is recovering or at the depths of recessions. Value stocks tend to be cyclical and get a boost when the economy is bottoming or improving. Growth works best when an economy is in late stages of expansion as the unit growth characteristics of growth companies become more highly valued as the economic tailwind slackens.
Neither model added or subtracted much from portfolio performance last month. Both models gained slightly over 2%, bracketing the 2.3% return for the S&P 500.
Disclosure: MDY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve Birenberg is sole proprietor of Northlake, an SEC registered investment advisor.