Like all networks these days, Discovery Communications (NASDAQ:DISCK) is having mixed success adjusting to fundamental shifts in the TV industry. Audience numbers are ticking lower, but the company is still squeezing more profits out of its core advertising business. Meanwhile, it is expanding overseas and aggressively investing in new digital distribution channels.
Investors will be looking for evidence of progress along Discovery's key growth strategies when it posts second-quarter results on Tuesday. Here are three big trends to watch.
An uptick in the U.S. business helped Discovery return to overall revenue growth last quarter after a disappointing 2% decline to end fiscal 2015. The segment bounced right back from that slip, though, expanding by 8% in Q1 as advertising sales rose 7% and distribution fees, which Discovery charges to cable operators for the right to carry its networks, jumped by 8%.
These results put Discovery in the middle of the pack among rival TV networks, besting Time Warner's (NYSE:TWX.DL) 5% uptick but coming short of Scripps Networks (NASDAQ:SNI) and its HGTV-fueled 14% advertising surge.
Discovery is the first among this group to announce Q2 results this year, so it will be investors' early look at the health of the U.S. advertising market. Besides solid ad sale growth and improving distribution fees, shareholders will be focused on the company's volume numbers. Higher prices have recently made up for the fact that the cable subscriber base is slowly shrinking. Discovery and its rivals can use that strategy to keep earnings rising -- as long as overall audience levels don't decline too quickly.
International TV markets are less mature than the U.S., and so they offer more potential for outsized audience growth. However, this segment of the business hasn't yet produced steady profit gains for Discovery. Foreign currency swings and rising content spending combined to push operating margin down to 26% of sales last quarter from 29% a year ago.
Discovery's 60% margin in the U.S. market shows just how far the company has to go to bring its international profitability up to par. However, investors can look for that gap to close in the coming quarters as content spending settles down to a more normal pace and as exchange rate movements become less of a drag on results.
Finally, shareholders will get an important update on Discovery's reorganization plan that involves a wide range of expense cuts, including job reductions. CEO David Zaslav told employees in May that the moves, which should be done by the end of Q3, are necessary to get Discovery on a stronger footing to compete in the media industry. "Shifting consumer behavior and new technologies are factors that have touched each and every one of us," he said about the digital disruption that's rewriting TV industry rules. "In making these hard decisions, we are positioning Discovery for many more years of success and growth as a leader in global entertainment."
While the cuts could raise Discovery's profitability, Zaslav and his team instead plan to plow most of the savings into the growth priorities of international expansion and digital over-the-top services. Management sees its core television business as having several years of at least modest growth ahead.
Beyond that, though, Discovery is focused on becoming a leader in online and international content delivery. That adjustment will significantly broaden its reach over the long term, but there's no guarantee that it will produce the same level of predictable, profitable growth that the TV network giant enjoyed in the past.