1Q22 Earnings Update: Part Three – VICI, NXST, SONY, DIS, HD

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VICI Properties (VICI):  VICI reported its typically boring quarter with results in line to slightly better than street expectations.  Boring is exactly what we like about VICI.  As a landlord to the nation’s two leading gaming companies, Caesars and MGM, VICI’s business model is highly predictable.  The company collects rents with built-in escalators.  Beyond the annual rent increases, VICI also grows by buying other casino properties.  Essentially, VICI acts as a financing partner for casino companies.

While 1Q22 offered little news in the reported results, it was a critical quarter for VICI.  The company closed on its acquisition of The Venetian, one the most significant properties on the Las Vegas Strip.  VICI also completed its merger with MGM Properties, combining the two largest Gaming REITs.  With the big deals closed, VICI issued updated guidance for the combined company that was in line with our estimates and slightly ahead of street estimates.  VICI pays out most of its earnings in dividends but there is several hundred million left over that the company uses for additional acquisitions that are smaller in scope than Venetian and MGM transactions.

We think a period of calm will be good for VICI shares as the power of the enlarged company can shine.  VICI is now one of the three largest REITs by market capitalization, something we believe will be a source of incremental demand from real estate focused investors.  The shares currently have a dividend yield of 5% and we expect dividend growth to be in the mid-single digits annually.  We expect the multiple to expand as investors gain appreciation for VICI’s business model and the acumen of its superb management team.  After never missing a rent payment during peak COVID, when many of its tenants shut their casinos, we have little concern about credit risk even if the economy slips into recession.  The primary risk in the shares is rising intermediate to long-term interest rates that weaken the relative value of VICI’s dividend yield. The combination of dividend yield, moderate earnings growth, and multiple expansion offers VICI shareholders upside of 15-20% in the next twelve months and a long-term return profile of 8-10% annually.

Nexstar Media Group (NXST):  Over the nearly ten years that we have been investing in NXST, we have grown accustomed to good earnings reports that meet or beat expectations and steady increases in estimates of free cash flow (NXST and other local TV station owners are valued primarily on free cash flow rather than EPS or EBITDA).  In our long history with NXST, 1Q22 was one of the best quarters.  Revenues, EBITDA, and free cash flow each comfortably exceeded our own and Wall Street estimates.  Perhaps more importantly, management indicated no slowdown in advertising or the net retransmission fees it receives from cable, satellite and vMVPDs (YouTube TV, Sling, Hulu Live TV) despite the war in Ukraine, rising inflation and interest rates, and investor fears of an imminent recession.  Other local TV broadcasters offered similar comments.

We attribute the company’s outlook and performance to its best-in-class management team that executes flawlessly on sales, expense control, free cash flow conversion, and mergers and acquisitions.  On its 1Q22 conference call, management noted multiple times that its three-year outlook is strong and has high visibility.  Political advertising looks set for one of its biggest years ever this year with control of the House and Senate at stake.  The Presidential election in 2024 will surely be hard fought and the House and Senate will likely still be close to evenly divided.  Retransmission fees should take a step up as a new round of negotiations is underway with local TV channels still underpriced relative to their viewership share.

NXST will generate free cash flow of about $1.4 billion per year in 2022 and 2023, which equates to over 20% of the current stock price.  Capital allocation includes steady increases in the dividend, significant share buybacks, and tuck-in acquisitions of digital properties that enhance the national reach of the company’s TV station group.

NXST shares reached $190 before the market correction.  We think the stock can get back there and reach $210 assuming 2022 and 2023 results meet expectations.  The primary near-term risk is a recession that impacts the company’s advertising.  However, core advertising (non-political ads) is only around 30% of revenues now vs. 80% during the 2007-2009 Great Financial Crisis.  Despite what many investors think, local TV broadcasters are not particularly economically sensitive.  Long-term risk emanates from changing TV viewing habits that could reduce time spent with the company’s local news broadcasts.

Sony (SONY):  SONY reported results in line with investor expectations for 4Q21 (which ended on 3/31/22).  Looking at the full fiscal year, operating income came in about 20% above initial guidance.  SONY typically guides conservatively.  This gives us great comfort that the newly issued guidance for a small decline in operating income in FY22 will prove conservative.  This especially appears the case in the company’s Gaming segment where management is guiding to a 34% revenue gain but unchanged operating income.  Guidance in Music calls for continued growth fueled by streaming and label acquisitions.  Image Sensors used in mobile phone cameras should grow as well although COVID lockdowns in China could prove a challenge for the supply chain.  Pictures will have a down year comping against the massive success of the latest Spiderman movie, which is one of the all-time box office leaders.  These four businesses provide the bulk of SONY’s earnings and are key to why we think the stock is significantly undervalued.  SONY shares have performed poorly this year, pressured by fears about the impact of Microsoft’s proposed acquisition of Activision Blizzard.  SONY and Microsoft are big rivals in gaming consoles (PlayStation vs. Xbox).  The stock has also been under pressure due to significant weakness in the yen vs. the dollar and multiple compression that has hurt all growth stocks.

We are encouraged by the recent improvement in SONY shares relative to the market.  SONY shares are unchanged since April 27, while the S&P 500 is down 6% and the NASDAQ is down 7%.  We think this is just the start of improved performance for SONY.  The stock trades at less than 8X EBITDA while peers in the video game, music, semiconductor, and film and TV production industries trade at significantly higher multiples.  SONY’s results are never linear due to the company’s complexity and conservative financial reporting practices.  However, we expect the company to materially beat its 2022 forecasts and its recently issued three-year forecasts.  This should allow multiple expansion to 10X, which gives us a target of $120, up more than 40% from current trading levels.

Disney (DIS):  DIS shares have been the worst performer in the Dow Jones Industrial Average so far this year, driven lower primarily by the collapse in Netflix shares.  Netflix’s weak subscriber growth and lowered profit margin forecast have undercut confidence in DIS’s own transition to streaming despite better-than-expected growth in subscribers at Disney+.

DIS had solid results in 2Q22 but cautious comments on the company’s conference call for the balance of FY22 have pushed the shares lower again.  Higher expenses in streaming reinforce the worries triggered by Netflix’s margin guidance.  Investors are asking if streaming will ever produce material profits.  Netflix also has raised worries that DIS subscriber growth will fall short of management’s expectations of 230-260 million at Disney+ in 2024 (currently near 140mm).  On the 2Q conference call, management noted that the incremental growth in subs in 2H22 vs 1H22 would be less than previously forecast.  Investors interpreted this news negatively, but we would point out that 1H22 sub growth came in well ahead of expectations and there is no change to the number of new subs expected in 2H22.  We remain confident that streaming subs are on track given many new countries are being launched later this year and a surge in fresh content is coming now that COVID is no longer impacting production schedules.

While we wait for clarity on long-term streaming trends, Disney’s theme parks are booming.  Domestic theme parks are already operating well ahead of 2019 pre-COVID levels and international visitation has barely restarted.  If we value DIS at 12X EBITDA reflecting a premium for theme parks and the film studio and a discount for traditional media, we get a value of $100 per share.  This approach embeds a multibillion-dollar loss on streaming.  At our 12X multiple, this equates to $30 billion of market cap or about $20 per share.  Netflix may face growth concerns, but it is profitable today and valued at $90 billion.  Each $10 billion in value ascribed to DIS streaming is worth about $4 a share.  We feel extremely comfortable valuing DIS streaming at 80% of Netflix which would equate to a target of $130 for DIS.  We feel this target is conservative but realistic until investors regain confidence in long-term streaming economics.  While $130 is well below targets of over $200 we held previously, it is enough to keep us long DIS shares ahead of what we hope will be better news on streaming later this year.

Home Depot (HD):  HD reported excellent 1Q22 results and, in an unusual move, raised its full year guidance.  The news was good in almost every area with profit margins a highlight for us after so many recent quarters where margins seemed to trip up the investment thesis.  Good margin performance contrasted with the big earnings misses and guidance reductions at Walmart and Target due to the impact of inflation and supply chain problems.  The conference call overall was quite bullish, much more so than in we usually hear from HD’s conservative management team.

Unfortunately, HD shares gave up all their initial gains and fell sharply along with the rest of the retail stocks after the plunges in Walmart and Target stocks.  If there was one issue that worried HD investors, it was related to composition of the 3% comparable store sales gain.  The gain was made up of 11% price increase and an 8% decline in traffic.  Given current Wall Street worries about a recession driven by a pullback in consumer spending, the traffic decline is worrisome.  However, HD reminded investors that (1) it gets a significant portion of its sales from contractors or Pros, and (2) Pro demand reflects the spending by consumers.  Management also offered an interesting take on housing economy as it relates to the sharp jump in mortgage rates this year.  To summarize, there are about 130 million housing units in the US of which 100 million are either single family homes or non-rental properties.  Turnover of these homes in a typical year is 4-5 million units.  Of the reaming units, about 85% have fixed rate mortgages.  These statistics suggest that the impact of higher mortgage rates is less than generally perceived.  Furthermore, management noted if homeowners feel unable to move because of higher mortgage rates on their new purchase, they may decide to invest more in their current home.  It crossed our mind that a shorthand way of saying this is that the industry is referred to as home improvement not new home construction.  Northlake would also believe HD is getting a boost from a secular shift of consumer budgets to the home driven by the COVID experience.  We continue to find HD shares attractive with a current target of $340 based on 15 times EBITDA or 20 times projected earnings.  This target is below our earlier targets since the market multiple has contracted sharply but provides plenty of upside for a blue-chip company in a tough market environment.

VICI, NXST, SONY, DIS, and HD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov. 

Boring is Beautiful at VICI Properties with Catalysts Ahead

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As a triple net lease real estate investment trust that owns casino real estate properties, VICI Properties (VICI) operates a highly predictable, low volatility business.  VICI is a landlord that is paid rent by casino operators like Caesars Entertainment and MGM Resorts.  4Q21 was no exception to VICI’s consistent financial performance with all reported key financial metrics right in line with Wall Street estimates. 

Stock Reaction:  Given the low-volatility business model, VICI shares normally do not react much to earnings.  The stock opened lower in a weak market, but during what we thought was a very bullish conference call the stock firmed up nicely.

Earnings Analysis:  The most important figure in VICI’s earnings reports is adjusted funds from operations (AFFO), which is a measure of recurring profits after maintenance capital expenditures.  AFFO is also a good measure of funds available for dividends; REITs are required to pay out the substantial majority of AFFO.  In 4Q21, VICI’s AFFO was 44 cents, down a few pennies from the year ago figure.  However, this understates VICI’s growth as it is depressed by the large share issuance related to the company’s soon-to-close acquisition of peer gaming REIT MGM Properties and just-closed acquisition of The Venetian Las Vegas Strip casino from Las Vegas Sands.  EBITDA grew over 5%.  Closing of these two major acquisitions are a catalyst for organic AFFO growth in the mid-single-digits in the years ahead.  Future acquisitions are likely, and can drive total growth to the upper single-digits.  Importantly, VICI has negotiated inflation protection into almost all its leases in the form of rent escalators.  Management issued guidance for 2022 of $1.80-$1.84 per share, but excluded any benefit from the MGM acquisition.  Analysts are estimating $1.94 as they include the acquisition.

The bulk of the questions on VICI’s conference call concerned the recent sale of Wynn Resorts Encore Boston Harbor at an all-time low cap rate (or all-time high multiple) to a new entrant to casino gaming.  Management feels the transaction highlights the underlying value of VICI’s large portfolio that includes several similar properties.  There could be concern that a new entrant is driving down the return on future acquisitions made by VICI, but we agree with management that presently the new entrant justifies VICI’s business model and shows that casino properties have been fully accepted by institutional investors.

Another highlight of the call was management recapping a series of capital improvements being undertaken by its tenants across several of its properties.  These property upgrades improve the credit quality and replacement value of VICI’s portfolio that already trades below replacement value.

Target Price:  We believe VICI shares can trade back to recent highs in the low $30s, producing a total return of 15-20% over the next year when including the current dividend that produces a 5% yield.  In a suddenly uncertain stock market environment, we find comfort in VICI’s predictability and the elevated dividend yield.  Catalysts ahead include the closing of the MGM Properties acquisition and increased ownership of VICI by REIT-dedicated funds as it will be one the top three REITs in terms of market cap.  Longer term, we see expansion in VICI’s multiple as casino properties proved their worth through COVID.  VICI never saw a missed payment in 2020 or 2021 even though many of its casinos were closed or operated with restrictions for long stretches.  The all-time record sale of Encore Boston to an established REIT, but new entrant to casino real estate, is a strong proof point for multiple expansion for VICI shares, which trade at a discount to other triple net REITs.

VICI is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov

Explaining Income Equities

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Beginning this quarter, we are adding a new blog post to cover the income-oriented stock and ETF ideas we have been increasingly using in client portfolios.  Not all clients use these investments, but we have broadened their use, so we thought it would be useful to produce summary commentary each quarter.

Up until 2020, most of the high-dividend paying stocks and equity ETFs had been purchased as bond substitutes.  Even prior to COVID, interest rates were at historically low levels that we found unattractive for long-term investment.  Northlake used stocks like Verizon (VZ), MGM Growth Properties (MGP), and Lamar Advertising (LAMR), and ETFs such as iShares Select Dividend (DVY).  These stocks and others served clients very well for many years.

Post the market collapse in March due to COVID, interest rates on money market funds have remained near 0% and the Ten Year US Treasury bond yield fell well below 1%.  Northlake made the decision to invest conservatively in 2020 due to the unusual risk surrounding COVID and the election.  We sold a lot of securities, and when we decided to begin reinvesting we saw high-dividend paying stocks and ETFs as a conservative alternative given our continuing concerns about the market.

Aside from credit quality, the primary risk for these investments is a sharp rise in interest rates.  Given the Federal Reserve and other global central banks clear guidance that they will keep interest rates low until the economy has moved well beyond the pandemic, we see little risk of significantly higher interest rates in the next few years.  A spike in inflation caused by excess monetary and fiscal stimulus could push rates higher, but we feel disinflationary trends from technology and the maturity of the U.S., Japan, and European economies makes sustained higher inflation unlikely.

Since the March stock market low, we have added to client holdings in DVY and Verizon and continue to own Lamar Advertising.  We substituted VICI Properties (VICI) for MGP and other high-dividend payers that we sold in March.  VICI was also added for a broader group of clients.  We also added two preferred stocks to our high-dividend portfolio, GCI Liberty (GLIBP) and Qurate Retail (QRTEP).  Each of these preferred stocks is part of Liberty Media, which we know well and have followed closely for 30 years.

VICI is a real estate investment trust closely tied to Caesars Entertainment.  The company acts as Caesars financing arm when real estate is sold but Caesars continue to manage and operate the property.  For example, VICI owns Caesars Palace, and Caesars Entertainment pays VICI under a long-term lease for the right to operate and manage the property.  VICI owns around 30 different casino gaming properties around the country.  Most are operated by Caesars Entertainment, but several other casino operators also have leases with VICI. There are two key aspects to our investment thesis on VICI.  First, despite the COVID lockdowns last spring, VICI received 100% of the rent payments it was due across its entire portfolio.  This speaks to the quality of the company’s cash flow used to pay dividends.  If COVID could not hurt VICI, it is hard to see a scenario that would impact the dividend.  Second, there remain many quality gaming properties throughout the United States still owned by the operators.  VICI has more opportunities with Caesars and we expect continued diversification to other operators.  VICI shares yield 5% and we think the company can sustain mid-single digit growth in dividends through rent escalators and more property acquisitions.  Northlake expects an attractive total return of 10% annually in a low interest rate environment with many unusual economic and market risks.

GLIBP and QRTEP are more like bonds given the fixed nature of their payments and maturity dates.  We see both stocks as a way for client accounts with a need for conservative investments to earn current yields well above money market and bond interest rates.

GLIBP is tied closely to Liberty Broadband (LDRDA) and Charter Communications (CHTR).  The primary support for GLIBP’s dividend payment is the GCI Liberty and LBRDA ownership of Charter Communications ownership of about 30% of CHTR.  CHTR is the second largest cable broadband company in the US and produces growing and stable free cash flow.  GLIBP pays an annual dividend of $1.75 for a current dividend yield of 6%.  The preferred matures in 2038.  Shares were purchased around $25 and now trade at $28.

QRTEP pays an $8.00 annual dividend which equates to a current yield over 8%.  The preferred matures in 2031.  Qurate Retail owns and operates QVC, HSN, and Zulily.  QVC and HSN have morphed from pure home shopping TV networks to ecommerce retailers with over half of current business done online.  We believe the 8% yield outweighs the risk of competition from Amazon and other ecommerce giants.  Qurate is growing, and the business produces very high free cash flow to support the QRTEP dividend.  Shares were purchased in the low-to-mid $90s and now trade at $99.

GLIBP, QRTEP, VICI, LAMR, VZ, and DVY are held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.