Street's stumbling start this year makes it harder to take stock in picks

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New year, new luck? Not so fast. MThe extended market rally for which some had hoped entering 2009 hasn't materialized. Despite the excitement ahead of Inauguration Day, trading conditions remain rough across the board, as evidenced by Tuesday's market losses, and the media and entertainment sector is no exception.

In this environment, there is a premium on smart stock picks.

After a couple of good days kicked off 2009, we quickly reverted to rocky trading for stocks in most sectors. The Dow and other major indices have pared the early gains and are running behind their year-end closes.

Given the recession, a credit crunch and other unwelcome distractions, this might come as a shock only to unrepenting bulls. Bleak unemployment and retail sales reports, as well as earnings-estimate reductions, seem to have confirmed fears of a prolonged recession.

Hollywood stocks also have felt pain after an earnings warning from Time Warner and more signs that the advertising and DVD markets soured further in late 2008.

No surprise, then, that The Hollywood Reporter Showbiz 50 stock index has seen declines like the broader markets, though it is slightly better than the broad-based S&P 500. As of Tuesday's market close, the THR Showbiz 50 is off 8.4% for the year to 646.51.

Two things provide hope: The drop is less than the 10.9% decline in the S&P, and by the same point in 2008, the Showbiz 50 already had lost 13.5%. Still, most analysts expect more choppy waters in the near term.

For the overall stock market, Citi chief U.S. equity strategist Tobias Levkovich said recently that investors are hoping for clearer earnings guidance, which they are unlikely to get in the current environment.

"This lack of clarity was evident (this month) at Citi's Entertainment, Media and Telecom Conference in Arizona, where the mood of company presenters could best be described as glum," he said.

Jefferies & Co. analysts also predict more difficult trading conditions for sector stocks.

"While we see select attractive opportunities, broadly speaking, we expect valuations to remain at trough levels until we get better visibility into an advertising recovery," media and Internet analysts Brian Shipman and Youssef Squali write. They warn that this could be several quarters away.

Their top picks for 2009 are DreamWorks Animation and Google, with Lionsgate getting an honorary mention.

"Media companies in our universe with little or no advertising exposure make good defensive plays," Shipman says. That's why he expects pure-play entertainment firms DWA and Lionsgate to outperform peers.

DWA is his top defensive play, with shares performing "exceptionally" relative to peers in 2008, down only 10% thanks to strong boxoffice performances from "Kung Fu Panda" and "Madagascar: Escape 2 Africa," he says.

Shipman expects that the success of those films will mean stronger-than-anticipated results in 2009. He also sees potential further catalysts, including the emerging "Shrek the Musical" business and the firm's ability to buy back shares.

Meanwhile, Google is better positioned than peers, "given its heavy exposure to search, which is performance-based and therefore less sensitive to budget cuts," Squali says. Barclays Capital Internet colleague Douglas Anmuth also recently picked Google as his top stock for 2009.

Barclays entertainment analyst Anthony DiClemente, meanwhile, is betting on a less obvious stock: Discovery Communications. He argues it "offers the best growth prospects across the entertainment space as we expect 7% year-over-year (operating cash flow) growth in 2009 versus an expected decline of 2% for entertainment on average." The company's steady affiliate fees, international growth and improving margins will boost its fortunes, he says.

Barclays analyst Vijay Jayant, who covers TV distributors, doesn't bet on biggies Comcast and Time Warner Cable, which others love for 2009. Instead, he likes maligned satellite TV operator Dish Network.

"Shares have underperformed the sector due to operational and competitive challenges and lack of management transparency," he says.

As an example, Jayant cites that Dish shocked investors with its first quarterly net subscriber decline last year.

But he argues that Dish stock has been oversold.

"The business is fundamentally stable with a strong liquidity profile, and (we) expect first-half 2009 results to display this stability, increasing investor confidence and enhancing focus on attractive valuation," Jayant says.

Media and entertainment companies might not know where their businesses are going in the face of a cloudy economic outlook, and if the first weeks of 2009 are a guide, then this year could see more stock losers than winners.

In this environment, picking stocks is a particularly important skill. Let's see if media industry analysts have what it takes.

Georg Szalai can be reached at georg.szalai@THR.com.
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