Thursday, November 19, 2015

Seven West Media Analysis and Valuation

When you want to look for value stocks, you want stocks that have been hated for 3 or more years, and deeply out of favour. Usually the reasons for the sell off are continuous disappointment in earnings, one off incidents of changing sentiment of the industry.  Most of the statistical studies on low price ratios like low price to book and low EnterpriseValue/EBIT have historically performed really well, better than your usual P/E or dividend yield returns which I hear being talked about regularly amongst the mum and dad investors.

Once in awhile, you get really large, well known Australian companies that fall out of favour, and I find these situations the best ones that retail investors should pay a little more attention to, due to the 'circle of competence' nature of these businesses.  If they are well known, they've had franchises of 'moats' that have opportunities to return to normal earnings and returns on investment.

Let's see firstly the price action, and how depressed it looks.

From a high of $15.16 in April 2007 to the current price 71c, 8 years later.  If sentiment is negative, we have passed the first hurdle of finding deep value.

Let's have a look at the DCF valuation using

I always want to find a tool that will quickly give me a visual way to see if there's a margin of safety.  Well SWM indeed has a huge margin of safety, almost 60% based on

Sometimes things can seem too good to be true, so let's be a little more diligent, I did my own back of the envelope calculations, which can be found here.

With a 0% growth assumption and 9% cost of capital, we are getting $1.67 which is close to the figure that is stating.

We all know DCF is unreliable, especially if the cashflows are volatile, but look at the last 5 years of Cash from operations, $141, $216, $343, $238, $283.  Looks like cash is increasing to me.

We have to ignore the last earnings per share figure, as it was the billion dollar writeoff on goodwill that would have forced the sentiment in SWM to go as low as possible, probably in the capitulation range.

Let's have a look at the balance sheet. (Sheet 3 in the google link).

Long term debt increased massively after the merger, but since then we see a decrease in the debt.

SWM had a share raising at $1.22, and now the company is being bought back at $0.68-0.78 range, it seems like the market should start thinking this company will survive, with strong cash flows and debt being at a more manageable level.  Psychologically at least, you think this is a really easy ride back to $1.20, because the people who are holding from that float aren't sellers.

Greewald EPV analysis
For those that prefer to value a company based on assets reproduction values also give us an range of $1.57 per share value, and and earnings power value of slightly above at $1.70, indicating the company still have a small competitive edge going forward.

Company Details and Industry Comments

I'm no expert but Tim Worner has been a destroyer of shareholder value since he took over as CEO. I believe his leadership as a negative for shareholders of the company, and a change in management might be a positive catalyst for the stock.

When an industry has been given as much negativity as free-to-air television, whether or not the industry will survive is the first priority of the investment to avoid catastrophic loss, but measuring the decline and whether there are catalysts to reverse the trend.

I don't foresee SWM strategy with Yahoo7 or Presto making any material impact to revenues, however the decline in newspapers are likely to continue, whilst Television will probably improve it's operational efficiencies on a steady to slow decline.  The slow decline will be the time needed to both operational efficiencies, share buybacks and potential re-rating due to improved industry conditions.

Free to air television has a moat, but it's currently earning lower than it's historical margins.  Magazines and Newspapers are definitely on a secular decline, and divestment whilst it's still profitable may be a good strategic option.  Digital is a wildcard, but unlikely to add any value in the short term.

Investment Case
Will the internet media streamers continue to make heavy inroads stealing viewers from their TV sets, or is there a possible integration between the two mediums?  Nobody can predict whether or not TV will make a recovery but I see Free to air television still able to earn returns above the cost of capital, and at the current price, we are looking for at least one last puff, maybe two.

Catalysts that could lead to convergence of share price to intrinsic value

  • Share buybacks
  • Potential Divestment of newspaper and print (unlikely, but possible)
  • Management Change
  • Future earnings report showing a small increase in revenues % 
  • Seven Holdings takeover

Entry: 70c,
Price target: $1.20-$2.00
Holding period: 3 years.