Commentary: Distributor stocks' defensive prowess puts them in Street's starting lineup


Big cable operators recently have signaled more sluggish subscriber growth in the seasonally weak second quarter after a stronger-than-expected first quarter. The figures also are expected to fall well short of the year-ago quarter when sub momentum is reported.

Nonetheless, investors bid up the two U.S. satellite TV stocks and nearly all cable stocks during the year's first half, and analysts continue to recommend the distribution sector thanks to its defensive characteristics. After all, a return to slight growth in the U.S. economy is not expected until the fourth quarter, and consumers will continue to suffer amid high unemployment well into next year.

"Investors with a more defensive tilt should invest in pay TV," Goldman Sachs analyst Ingrid Chung said in a report last week.

Echoes Credit Suisse analyst Spencer Wang, "Despite our revised forecasts, we rate the cable/satellite sector 'market overweight,' given the more defensive characteristics of the group as evidenced by the fact that our 2009 financial estimates remain almost unchanged."

Wang also highlights that with valuations at about 4.6 times estimated 2009 enterprise value/operating cash flow, industry stocks remain attractive, "particularly compared to historical cable valuations of five times-10 times."

He argues that special circumstances boosted first-quarter subscriber trends. For example, after a weak fourth-quarter 2008, consumers might have relaxed enough in first-quarter 2009 to fill pent-up demand. Plus, the digital TV switch likely encouraged consumers to spend on cable or satellite during the first three months of the year.

"The digital transition will be less of a benefit in the second quarter," the analyst says.

However, the underlying weakness of the U.S. consumer has remained unchanged. "Many economic indicators -- home sales, foreclosures, vacancy rates -- remain weak," and they affect the sector, Wang writes.

As a result, he reduced his second-quarter subscriber net-add estimates for Comcast from 607,000 to 450,000 and for Time Warner Cable from 307,000 to 223,000.

Chung expects both will report basic-cable subscriber declines during the quarter. She also has reduced her forecasts but continues to tout distribution stocks as "relatively 'recession resistant,' " highlighting that firms have maintained at least mid-single-digit revenue and operating-cash-flow growth despite the recession.

But where in the sector have investors put their money this year, and which stocks do Wall Street analysts like best right now?

Small cable operators Knology and Mediacom Communications, which aren't covered as widely by analysts, and Dish Network, despite its legal battle with DVR pioneer TiVo, have done particularly well year-to-date. DirecTV also is up for the year despite a strong 2008, and cable giant Comcast was down at the midyear mark.

Still, analysts remain bullish on Comcast. Chung ranks the stock her favorite in the space, arguing it is "the best idea for those with a defensive tilt." She also lauds its "compelling" valuation and free-cash-flow yield.

Miller Tabak analyst David Joyce also likes Comcast but prefers Time Warner Cable, which he rates a "buy" with a $45 one-year price target. Although until Monday he had a $48 target on the stock -- he trimmed it because of sluggish sub momentum amid lower pending U.S. home sales -- he says the new target is "still a 52% increase potential from current levels."

Time Warner Cable remains one of the most controversial distribution stocks. Chung has only a $30 target and a "sell" rating, as does Pali Research analyst Richard Greenfield. The latter has expressed concern about solid momentum and offerings from Verizon's FiOS TV service, especially in the cabler's New York market.

Meanwhile, Wang rates Comcast "outperform," with a $16 target, and is "neutral" on Time Warner Cable, with a $35 target. "TWC's fundamentals will largely mirror Comcast's," he wrote last week. "However, in the current market environment, our 'neutral' rating primarily reflects TWC's greater leverage."

Another New York player, Cablevision, has earned kudos on the Street for ongoing solid execution and a recent Supreme Court decision not to hear a legal challenge regarding its network DVR.

"For cable operators like Cablevision, (such) DVRs potentially mean much lower capital spending going forward," says Sanford C. Bernstein analyst Craig Moffett, who has an "outperform" rating on the stock and a $20 price target.

DirecTV last month received a vote of confidence from Greenfield, who initiated the stock with a "buy" rating and a $32 price target.

"Digital channels, DVRs, TiVo interface, HD channels and remote scheduling illustrate how DirecTV has been able to continuously innovate to stay ahead of its rivals, despite an increasingly competitive multichannel landscape," he said.

Let's see which distribution stocks do best during the back half of the year. The upcoming second-quarter earnings season could be the first catalysts for moves in either direction.