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Is Charter Communications a Buy?

By Demitri Kalogeropoulos – Apr 13, 2018 at 9:47AM

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Why the cable giant could deliver good returns following its merger with Time Warner Cable.

The cable TV industry has a few characteristics that make it attractive for investors hunting for market-beating returns. It's dominated by just a few companies, for example, and these giants aren't easy to challenge given the tens of billions of dollars they have invested into building TV, internet, and voice networks over the years.

In addition, their earnings come from steadily recurring monthly subscription fees that are spread out over a huge customer footprint and tend to rise with added offerings like high-definition, and they can entice customers with things like triple-play bundles that provide internet, television, and phone services. As a result, cable titans often post healthy increases in both sales and profits.

With that broader picture in mind, let's look at Charter Communications (CHTR -3.68%), the industry's second largest player, to see if it makes a good buy for investors today.

A man watches television.

Image source: Getty Images.

Charter Communications stock:

Metric

Charter Communications 

Market cap

$88 billion

Revenue*

$42 billion

Sales growth*

43%

Profit margin*

24%

Price-to-earnings ratio

9

Price-to-sales ratio

2.1

52-week stock price performance

(4%)

*Revenue, sales growth, and profit margin over the last complete fiscal year. Data source: Company's financial filings.

An attractive model

Charter recently wrapped up a banner fiscal year during which sales increased 43% and operating income improved to $4.1 billion from $2.5 billion. Most of that boost came from its acquisition of Time Warner Cable, but organic growth was solid, too.

The company notched minor increases in its customer base as cord-cutting slowed in the TV segment and people snapped up its high-speed internet offerings. All told, Charter's footprint rose to 27.2 million paying customers from 26.2 million. These subscribers paid an average of $109 per month for their services, or about the same monthly rate as in 2016. Rival Comcast (NASDAQ: CMCSA) counted 27.2 million residential customer relationships at the end of 2017, and its business expanded slightly as well. 

Programming expenses were by far the biggest drag on earnings growth, and investors can expect that trend to continue for the foreseeable future. Still, Charter's overall costs grew at about the same rate of sales, leaving adjusted operating margin unchanged at 37% of sales. 

Risks and outlook

There are risks involved with owning this business, and one of the biggest is debt. It requires a lot of cash to build out and maintain vast cable and fiber optic networks, after all. Charter spent $8.7 billion on these assets last year, or about twice its annual free cash flow.

That gap means the company must rely on debt, which currently sits at $69 billion, or 80% of its market capitalization, to put Charter near the top of management's range of where it wants leverage to be.

A family watching TV on the couch.

Image source: Getty Images.

Another risk to watch is the ongoing integration of the Time Warner Cable business. Charter executives made positive strides on that task last year, but management plans to devote plenty of additional capital and attention to the merger through 2018.

That integration might end up costing more than planned, or it could ultimately deliver less of a sales and profit boost than management had originally hoped.

Yet for now, Charter appears to be in a solid operating position that should allow for sales growth in the 3% to 5% range and slightly faster earnings gains as its customer base inches higher. It doesn't have nearly the revenue diversity that Comcast enjoys, and so it's more exposed to another downturn in the cable TV subscription business.

On the other hand, that focus should translate into better customer service, which is the long-term driver of market share growth. I'd expect the stock to benefit from these gains over the next few years, especially as management squeezes more efficiency out of its new, larger sales footprint. Thus, if you're looking for exposure to this mature -- but highly profitable -- industry, Charter deserves a spot on your watchlist. 

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Comcast. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Charter Communications, Inc. Stock Quote
Charter Communications, Inc.
CHTR
$321.66 (-3.68%) $-12.30

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