Wall Street's Hollywood Stock Picks for 2018

Traders work on the floor of the New York Stock Exchange  - Getty 2018
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Disney, Fox, CBS Corp. and Lionsgate are among analysts' recommendations as investors remain wary of sector stocks.

After a year of underperformance amid severe digital disruption, there's money to be made in entertainment-media stocks, if you know where to look.

So where should media and entertainment investors put their money in 2018? Many Wall Street analysts predict that concerns about industry fundamentals won't subside in 2018, but tax reform and talk of potential mergers will drive certain stocks higher. 

"The start of 2018 feels similar to the start of 2017, with the primary differences being clarity on (rather than expectation of) tax change specifics and proposed corporate consolidations," Guggenheim Securities analyst Michael Morris wrote in a Wednesday report.

First, the bad news: 36 of the stocks followed by The Hollywood Reporter underperformed the Dow Jones Industrial Average in 2017, and many might do so again this year.

"We expect the tension between the bull case on media (low relative valuations) and the bear case (ongoing secular pressure on consumption trends) to be intense during the first several months of the year, though we expect secular trends to ultimately overwhelm, further pressuring media valuations in aggregate," Morris wrote.

A team of Macquarie Capital analysts similarly said: "We expect old media to continue to stagnate, distribution to continue being disintermediated, ... but M&A remains a key catalyst."

With that background, Wall Street analysts are picking their favorite stocks for the new year. 

Morris recommends investors focus on companies with strong content creation and direct-to-consumer potential. His top stock picks in the sector are Netflix, Comcast and CBS Corp.

"We see these companies as better positioned than peers to navigate industry changes, capitalize on new opportunities and/or have lower expectations embedded in consensus expectations," he explained. "We maintain a preference for companies that we view as secularly better positioned (Netflix), have attractive incremental organic investment opportunities (Comcast) and/or maintain significant upside even as the traditional bundle erodes (CBS Corp)."

MoffettNathanson analyst Michael Nathanson, meanwhile, has "buy" ratings on Walt Disney and 21st Century Fox, which he had on his even before their big semi-merger was unveiled last month.

About a year ago, he had argued that "media companies with high exposure to live sports and news ratings, affiliate fee pricing power and diverse revenue bases will outperform." After a late 2017 trip to L.A., Nathanson said "we came away convinced that the speed of change has forced every executive to acknowledge that the world is now truly different."

But Nathanson is less bullish on other entertainment stocks, remaining "neutral" on CBS, Scripps Networks, Time Warner and Viacom, while having "sell" ratings on AMC Networks, Discovery Communications, as well as Regal Entertainment Group and Cinemark "as we continue to see further risk at pure-play cable networks and exhibitors from the fundamental challenges that lie ahead.”

RBC Capital Markets analyst Steven Cahall's top Hollywood stock pick is Disney. "Investors seem to have a newfound respect for what it feels like when a stalwart like Disney flexes its muscles," he wrote in a report after the company made its Fox deal official.

“With a shift to direct-to-consumer, declining relative contribution from ESPN and strong growth in non-media segments, we see Disney as increasingly an execution story at parks (operating leverage) and studio (storytelling),” he argued. “Disney is an excellent executor, so we see this risk as manageable.”

Concluded Cahall: “Disney is also the least media company in media due to the non-media assets. We see non-media Disney getting fair value as the earnings come through, driving a [stock] rerating and supporting our top pick rating.”

Beyond Disney, Cahall also recommended Lionsgate, due to its "strong organic earnings growth and take-out optionality."

"M&A has made the space a bit more ownable, but fundamentals remain uncertain in the eyes of the market," Cahall wrote in his 2018 preview. With this in mind, he recommends sector investors focus on stocks with defensive characteristics "as we think limited downside provides the best path to earnings-driven stock appreciation and multiple expansion."

Steven Birenberg of Northlake Capital Management says that Nexstar Media Group is one of his firm's two largest holdings, given his positive view of local TV station owners.

"The industry has tailwinds from Olympic and political spending in 2018 and is a beneficiary of tax reform. Accretive acquisitions are also likely in the industry and OTT services do not seem to be threat as they all are emphasizing local stations in their lineups," said Birenberg.

His other top holding is Reading International, an owner of theaters in the U.S., Australia and New Zealand, because the theaters form the basis for a real estate development company that has two major projects in New York.

"The company's project at the former Tamany Hall on Union Square in New York should be leased later this year, unlocking material value in the shares," he said. "Backing out the value of the real estate leaves the theaters at a reasonable multiple, and the company is starting to benefit more from its late start upgrading to luxury seating and amenities."

Among large caps, Birenberg's favorite is CBS, because he sees it as insulated from problems facing cable networks and because it is "a leader in OTT with All Access and Showtime."

He said that retransmission remains a growth driver for several more years at CBS and adds: "Maybe the Redstones will throw in the towel like the Murdochs. If so, CBS is an incredibly attractive target. The big worry is CBS will be forced to combine with Viacom. Investors hate the idea, but the financial side of a well-constructed deal could be quite positive."