Established media companies like Warner Bros. Discovery (WBD 3.08%) that own top movie studios may have natural advantages to compete with Netflix and Disney, given their century-long heritage of delivering countless blockbusters on the silver screen.
But the company's investments in streaming are coming at a big cost as the latest financial results revealed. A weakening advertising market caused Warner Bros. Discovery to miss analysts' estimates on revenue and earnings in the fourth quarter.
Still, Warner Bros. Discovery has a load of top entertainment properties to monetize over the long term, and the stock looks cheap, trading at just 9 times trailing free cash flow. Let's weigh its strengths and weaknesses to determine if the stock is worth buying.
Warner Bros. Discovery has strong entertainment brands
What jumps out when looking at Warner Bros. Discovery is its impressive lineup of top entertainment properties to monetize and drive growth over the long term. Some of the notable franchises it has in its arsenal are Harry Potter, Game of Thrones, DC superheroes (Superman and Batman), and Lord of the Rings.
Warner Bros. added 1.1 million subscribers in its direct-to-consumer business over Q3, bringing the total to 96 million. The segment's adjusted (pro forma) revenue also grew 6% year over year. The recent release of The Last of Us on HBO Max attracted 35 million viewers for the first episode, and the company has another catalyst in the near term with the relaunch of HBO Max that will include programming from Discovery+, which should offer better value to consumers.
The company also has a strong film slate for its studios and home entertainment business. Segment revenue fell 23% year over year in the quarter, but that was mostly driven by release timing. Overall, the future looks bright here.
Management is planning a multiyear release schedule for DC studios across film, TV, and animation that could unlock tremendous value from Superman and Batman properties. There are five films and five TV series already in the works, including the first stand-alone Superman film in a decade, scheduled for release in 2025.
While Netflix has been investing more in mobile games to engage its members, Warner Bros. may already be well ahead of its competitor in this important opportunity. In February, Warner Bros. launched Hogwarts Legacy from the Harry Potter franchise for console and PC. The game will probably be one of the best-sellers of the year, with over $850 million in retail sales since its release.
The success of Hogwarts shows that Warner Bros. may have a substantial long-term opportunity to monetize its top movie franchises into quality gaming experiences to drive growth in the $200 billion gaming industry.
Why investors should avoid the stock
Unfortunately, the advantages Warner Bros. has in film and digital entertainment are not enough to offset the decline in the TV networks segment.
The main engine of the company's revenue is still advertising and given the macroeconomic headwinds, the company reported an 11% year-over-year decline in total adjusted revenue last quarter.
The weak ad market puts more emphasis on Warner Bros. finances; it ended the year with $49.5 billion in long-term debt. To its credit, Warner Bros. generated a healthy amount of free cash flow last year of $3 billion, and it paid down $1 billion of debt in Q4, but it's still highly leveraged.
Compared to Netflix and Paramount Global, Warner Bros. has the highest debt-to-asset ratio, which adds risk to the investment case.
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Moreover, management disclosed on the earnings call that underlying advertising trends continued to weaken through Q4, and this trend was "further exacerbated by general entertainment audience declines."
Meanwhile, Paramount Global reported an increase in Q4 revenue of 2% over the year-ago quarter. The CBS owner added more subscribers to its streaming services (Paramount+ and Pluto TV) than Warner Bros.
The real winner in streaming right now is Netflix. Big Red is earning an industry-leading profit margin of 14%, while competing streaming services struggle to show a profit.
Netflix stock has outperformed both Warner Bros. and Paramount over the last year, and in my view, its superior financial position makes it the safest streaming stock to buy in 2023.
