The rules in this weekly column are simple. I bash a stock that I think is heading lower, and I offset the sting by recommending three stocks as portfolio replacements.
Who gets tossed out this week? Come on down, Warner Music Group
The headlines covering the record label's fiscal second quarter this month were surprisingly upbeat.
"Tune Turns Uptempo for Warner," wrote Forbes. MarketWatch, the Associated Press, and The Wall Street Journal all chose to point out narrowing losses.
I guess I'm singing a different tune, because I didn't see a lot to be cheerful about in Warner's report.
Revenue fell by just 1% to $662 million, but the decline would have been 6% without the period's foreign currency swings. Even that may not seem all that bad, but we're comparing these small steps down with last year's depressed results. A year ago, revenue fell by 17% (or 10% on a constant-currency basis).
Operating profits climbed sharply, but $24 million is no match for $46 million in interest expense. That's the curse of being in a fading industry, with $1.9 billion in long-term debt anchoring you down.
Warner has been smart enough to embrace digital distribution with aplomb. That niche continues to grow and now commands a respectable 30% slice of the revenue mix. However, it's not enough to prop the label back up.
Warner has posted six consecutive quarterly losses. Even though its deficit numbers improved in the latest quarter, analysts see a wider loss for the current quarter.
Is there any hope? If the only good thing you can say about a label is that it caught a break when it missed out on acquiring the EMI sinkhole, it's hard to get optimistic.
Major labels aren't as necessary as they used to be. Unless Warner begins growing again -- or at least generating an operating profit large enough to overcome its hefty debt burden -- it's probably best to leave this investment on mute.
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
(NYSE: ETM): There was a time when terrestrial radio was as doomed as the labels that feed them hits, but that's starting to change. Entercom is one of the country's five largest operators, with more than 100 radio stations in 23 markets. Its latest quarter was solid. Revenue climbed by 7% to $80.8 million, and it posted its third consecutive quarterly profit, with free cash flow more than doubling to $10.1 million. Other broadcasters show similar signs of life. Radio One (Nasdaq: ROIAK), with its emphasis on urban markets, is still losing money, but its core radio business has returned to revenue growth, according to the quarterly report that came out earlier this week. Terrestrial radio appears to be overcoming the challenge of satellite and Internet radio, through providing the necessary localized broadcasts.
Sirius XM Radio
(Nasdaq: SIRI): The good times are rocking and rolling again for the nation's satellite-radio monopoly. After three consecutive quarters of net subscriber growth, Sirius XM is no longer on any endangered-species list. The company raised its full-year guidance this week and now expects to close out 2010 with 750,000 more subscribers than it started with. With revenue of roughly $2.75 billion, adjusted operating profits of $575 million, and at least $100 million in free cash flow, it's a media giant that can't be taken lightly.
(Nasdaq: AAPL): The labels aren't the only beneficiaries of the digital-music revolution. Apple, Amazon.com (Nasdaq: AMZN), and Best Buy (NYSE: BBY)are all selling digital downloads these days. For Amazon and Best Buy, MP3s are simply replacing what they were previously selling as CDs, but at Apple, the iTunes Music Store is the undisputed market leader. Apple also includes GarageBand, a primitive yet presentable home-recording program, with all of its Macs as part of the iLife software suite. By making music creation easier, Apple is fueling the popularity of garage bands everywhere that can now use social networks instead of major labels to get heard.
Sorry, Warner, but you've been unplugged.
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Longtime Fool contributor Rick Munarriz owns no shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.