I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But some growth stories are inevitably better than others. Hence this regular series. My goal? Out the fakers, elevate the breakers, and examine the growth stories stuck in between.
Next up: Cablevision
|CAPS stars (out of 5)||*|
|Bullish pitches||17 out of 33|
|Highest-rated peers||RRSat Global Communications Network, Asbury Automotive Group, Time Warner|
Data current as of March 30.
Most Fools loathe Cablevision because of its valuation and the industry it occupies. They don't believe a classic entertainment conglomerate deserves to trade for 28 times earnings, especially after parting with one of its finer properties in Madison Square Garden
I'm not buying it. But that's also to be expected; I'm the guy who picked Cablevision as the best stock for the year ahead. My pick is trailing the market by three percentage points thus far, thanks in part to a late winter dispute with News Corp.
With the fighting subsided, I'm convinced that Cablevision will get back to its winning ways and reward shareholders via a spinoff of its Rainbow Media Holdings subsidiary, which owns premium channels AMC and iFC.
You might know AMC, which produces the hit shows Mad Men and Breaking Bad. Its latest, The Walking Dead, enjoyed stellar ratings in its debut last fall and a new show, The Killing, premieres Sunday. In each case, AMC has set a high bar for quality visual storytelling and created a media empire that's beginning to look a lot like what Harvey and Bob Weinstein created with Miramax Films.
To be fair, it's tough to know exactly what Rainbow Media is worth. But taxing its $282 million operating profit at a 40% rate puts the subsidiary's per-share earnings at $0.56. Applying the industry standard multiple of 11.6 values the business at $6.49 per share, versus $27.84 for the remainder. At that rate, the core Cablevision business trades for 34 times its $0.83 in normalized 2010 profit. So again, the stock looks expensive.
The elements of growth
|Normalized net income growth||23.0%||245.0%||Not material|
|Shares outstanding (million)||295.2||302.0||297.1|
Source: Capital IQ, a division of Standard & Poor's.
But looks can be deceiving, and they are here. Cablevision freed itself of heavy expenditures when it let Madison Square Garden loose and that's resulted in dramatic improvements in the underlying cost structure of the business, which in turn should increase earnings power.
- Growth investors like me love straight-line accelerating revenue growth leading to accelerating profit growth. There isn't much to report here, but only because Cablevision is too big and old to generate massive growth at this point in its life as a business. Single-digit gains are to be expected.
- Pricing power is also something we like to see. Or, in lieu of that, excellent cost management leading to higher margins. Here's where I get interested. Not only has net income improved dramatically over the past two years, but operating margins doubled in the fourth quarter -- from 3% to 6.1% -- as its cash flow margins zoomed north of 25%.
- We also like businesses that collect quickly. Cash generation is where Cablevision is at its best. The company has produced more than $1 billion in cash from operations in four of the past five years, more than enough to return capital to shareholders in the form of a 1.4% dividend.
- Finally, Cablevision has done well keeping a lid on dilution. Management has repurchased more than $140 million worth of stock in the past year alone.
Competitor and peer checkup
Normalized Net Income Growth
Time Warner Cable
Source: Capital IQ. Data current as of March 28.
Here's where the bears make their case. Cablevision may look good now, but what about a year from now? Management hasn't found a way to grow the top line consistently. Revenue fell in 2008, a year in which Comcast enjoyed double-digit growth.
These are important points. The truth is, I'm far less confident of Cablevision's long-term growth story than I am of a short-term turnaround and the possibilities offered by owning a stake in Rainbow postspinoff. But either way, there's no denying the cash-generating power of the underlying business. Ignoring that would be folly, which is why I've rated Cablevision to outperform in my CAPS portfolio.
Do you agree? Disagree? Let us know what you think about Cablevision's products, strategy, and valuation using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.
In the meantime, keep tabs on Cablevision or any of other stocks mentioned here by adding them to your watchlist for free, personalized stock tracking.