Five Take-Aways From Second-Quarter Earnings Season
With all entertainment conglomerates having reported their latest quarterly financials, Wall Street has started turning its attention to the question of what lessons earnings season offers for investors.
Most quarterly results were mixed bags this time around. And management teams in many cases signaled that while there are near-time challenges, they remain bullish longer-term.
Here is THR's look at five themes and lessons from the latest quarterly earnings parade:
1. Revenue weakness was offset by earnings strength in the second quarter.
"Every media company we cover missed consensus [expectations] slightly on revenue and met/beat on earnings, except Viacom," Sanford C. Bernstein analyst Todd Juenger wrote in a report.
Observers cited sluggish advertising revenue as one contributor to weaker-than-projected revenue trends, but cost controls, high-margin digital content deals and stock buybacks boosted bottom line results. Plus, "media [profits] are benefitting from fast growing affiliate fees," Nomura analyst Michael Nathanson said.
2. Olympics advertising challenges will be felt in the current quarter.
Compared to our expectations coming into second-quarter earnings, advertising was relatively soft," Nathanson said.
And several companies, including Discovery Communications and Time Warner, cited advertising challenges in the current third quarter amid the London 2012 Summer Olympics. (link to my story from Friday)
"We believe the "Olympics excuse" of decreased third-quarter advertising for non-NBCUniversal networks, despite a "healthy" ad market, is legitimate," Juenger said. "If the Olympics garner $1.2 billion of spending, that implies the other networks down 14 percent year-over-year in aggregate if the total market is up 3 percent."
Morgan Stanley analyst Benjamin Swinburne also emphasized that second-quarter national ad growth came in below his expectations, "while nearly every network group cited further softness in the third quarter from lower availability of scatter inventory caused by Olympic viewing."
As such, he has reduced his third-quarter growth estimates by three percentage points. But the "core local outlook for the third quarter was modestly better than expected, with benefits from political coming into full swing in the second half," he said.
Barclays Capital analyst Anthony DiClemente argued that all-in-all, "management teams were constructive on the tone of the ad market." Upfront pricing should benefit fourth-quarter results, he said. And "given the backdrop of an increasingly contentious election cycle this fall, we expect demand for local market inventory will not only provide a windfall of revenues for the TV station groups, but also a crowding-out effect - a scarcity of available inventory-that should funnel excess demand to the national cable and broadcast programmers."
3. Network carriage fees continue to provide strong growth.
Network carriage fees were one of the bright spots in entertainment conglomerates' quarterly earnings.
"For the companies we cover, affiliate fees increased 8 percent, excluding digital," Nathanson said. "News Corp. led its peers, benefitting from new affiliate fee contracts plus increased retrans fees."
And amid the recent stand-off between Viacom and DirecTV over network affiliate fees, CEO commentary on earnings conference calls "appeared to be more focused on long-term affiliate revenue growth prospects rather than the usual focus on the overall health of the advertising market," Swinburne said.
He added: "Viacom's favorable commentary on its DirecTV renewal appeared to overshadow its 7 percent decline in domestic advertising"
News Corp. brass spoke of double-digit U.S. affiliate fee revenue growth, while Time Warner cited similar growth ahead as some major carriage agreements start expiring in 2014.
4. Shareholder returns remain a top priority for Hollywood conglomerates.
"Within the media sector, capital returns to shareholders over the last several quarters have reached all-time highs, DiClemente wrote in a report. "Share buybacks accelerated from the first to the second quarter, and are expected to accelerate again in the third quarter."
Swinburne now predicts that sector giants will yield about 9 percent in shareholder returns in 2012, well above the 5 percent for the broad-based S&P 500 stock index. And Nathanson said that is "a far cry from what most investors would have imagined only a few years ago."
DiClemente also highlighted that despite its recent ratings challenges, Viacom is "leading the pack with a capital return ratio at 13 percent of market cap."
5. Analysts have a mixed outlook for big entertainment stocks:
Despite mixed quarterly results and Viacom's weaker-than-expected earnings, conglomerate stocks mostly rose right after the financial reports.
"The stocks' reactions to earnings have had little to do with fundamental performance, with Viacom up almost as much as Discovery," Juenger said.
Swinburne explained: "Concerns over a second-half ad slowdown proved warranted, but growing evidence of content pricing power and the benefit of share buybacks helped shares overcome this softer ad spend outlook."
DiClemente sees more upside for sector biggies ahead. "While the group has priced in a fair degree of...optimism, there are more arguments supporting media ownership than not," he said. "The impact of upfront pricing step-ups for the new TV season, the upcoming political ad cycle, little evidence of pay TV cord cutting, robust returns of capital and still-reasonable relative...valuations."
Nathanson similarly argued that sector stocks are being supported by growing carriage fees, capital returns and "a rotation out of other consumer discretionary stocks."
But he predicted that "media stock performance will have greater dispersion in the second half and into 2013."
So which Hollywood conglomerate stocks are the best current best?
"Investors should concentrate on companies that have mass, premium and non-replicable content like our "buy"-rated News Corp. and Disney," Nathanson said.
DiClemente said "we would probably choose to own the lowest-multiple media stocks right now - Viacom, Time Warner and News Corp."
And Juenger continues to like CBS Corp., but "prefer Disney and Discovery," while arguing that "recent optimism at Time Warner and Viacom will be short-lived."
Concluded the analyst: "Companies with earnings upside from re-pricing content are most compelling."