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Media – what price is right?

Investors should look to buy good businesses, but price still matters

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

A watch costing £800 might be a bargain if it’s Cartier, but not if it’s Casio. But a broken Cartier watch for £800 might not be as much of a bargain as a functioning one for £1,000. Good value is about both the price and the product.

The same is true of investing. A great company at a bad price can still be a bad investment, but a low price doesn’t necessarily make a bargain.

To illustrate the point consider ITV and Disney.

On the face of it they’re pretty similar businesses – both make money from traditional TV advertising, but also from content creation and monetisation. Both groups face headwinds from changing media consumption as viewers increasingly watch content on demand from challengers like Netflix, and are launching digital streaming services to compete.

Disney trades on a PE ratio of 23.5, while ITV trades on a PE of 8.8. Pretty different valuations for superficially similar businesses. But is Disney really a Cartier and ITV a Casio?

ITV – down not out

ITV’s valuation is the product of both company-specific and wider economic headwinds.

More than half of external revenues come from advertising – a segment which will boom and bust along with the wider economy and is facing massive disruption from digital streaming services. The group’s volatile revenues are compounded by its focus on the UK. With Brexit dampening consumer and business confidence, customers are reigning in their spending. These factors mean it’s understandable that investors are nervous.

ITV’s not standing still though, with the ‘more than TV’ strategy looking to grow non-advertising revenues. ‘The Hub’ and recently launched BritBox cater for the on-demand market, and the Studios business (which produces content for ITV and third parties) is continuing to attract investment.

It’s too early to tell if the strategy will crown ITV king of the jungle, but there are some promising signs of progress. Studio revenues have grown steadily, boosted by blockbuster programmes like Love Island, while pay-per-view sports events and daytime competitions have also proven lucrative sidelines.

ITV’s PE ratio of 8.8 times earnings is well below both its long run average of 13 and most of its peers. If the stock were to return to anything close to its long-term average PE ratio, that would imply significant upside, even before any earnings growth. That of course relies on the new strategy delivering results, and given the headwinds the group faces, that’s far from guaranteed.

For those prepared to back ITV CEO Carolyn McCall, there’s a 6.9% prospective dividend yield on offer over the next twelve months. The dividend is currently nearly twice covered by underlying earnings, which is right at the margins of what we’d consider OK for a cyclical business like ITV, and could mean it’s up for review. Fortunately, net debt of 1.1 times cash profits doesn’t look too demanding at the moment.

Despite the challenges facing ITV, the group’s valuation makes it potentially rewarding for those prepared to take the plunge. There are risks too though, and ITV could yet turn out to be more Casio than Cartier.

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Disney – a pricier powerhouse

It might be better known for its films and theme parks, but the largest contributor to Disney’s profits is Media Networks. ESPN, ABC, and Disney, along with a host of regional US channels, expose the group to the ups and downs of the advertising industry.

Thanks to the acquisition of 21st Century Fox, this segment now has more names in the mix, National Geographic being one of them.

However, what sets the group apart is its ability to repackage and monetise a killer back-catalogue of content. The Studios business means the portfolio’s growing all the time – with the recent additions to the Marvel and Star Wars franchises smashing box office records.

It’s a surprisingly short leap from soft toys and rollercoasters to an in-house streaming service. ESPN+ and Hulu are already big players in the TV streaming market and Disney+ is expected to launch later this year, another way for the group to squeeze extra cash from its existing content.

New products aren’t free of course, and recently we’ve seen short-term hits to profits and free cash flow as investment in direct-to-consumer platforms has grown.

Spectacular intellectual property and potential for significant growth hasn’t gone unnoticed by the market though. Disney’s PE ratio of 23.5 times is well above the long-term average of 16. Meanwhile the group’s 1.4% dividend yield is below the market average for the next twelve months.

Disney might be the Cartier watch of the media world, but investors should ask themselves whether it’s a good value Cartier.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. All figures correct as at 02/09/2019. Past performance is not a guide to the future.

This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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