Shares of Time Warner (NYSE:TWX.DL) have fallen nearly 25% over the past 12 months due to ongoing concerns about cord-cutting and the future of the company's film business. But after that steep decline, is this media stock getting too cheap to ignore? Let's examine Time Warner's problems, its potential catalysts, and its valuations to decide.
What's wrong with Time Warner?
Last quarter, Time Warner's revenue fell 5.9% annually to $7.08 billion and missed estimates by $450 million. Warner Bros. (movies, video games, and network TV) revenue fell 13.4% to $3.31 billion, mainly due to a lack of hit movies topping last year's Hobbit sequel and Interstellar.
Turner and HBO respectively posted 2.1% and 5.5% sales growth, but that strength failed to offset theatrical declines. Many analysts had also expected HBO to post stronger year-over-year growth. Turner's ad revenues rose 5% to $52 million, although its subscription, content, and other revenues remained flat. HBO also reported that international licensing contributed to a 20% jump in its "content and other" revenues.
On the bottom line, Time Warner's adjusted EPS rose 8% to $1.06, beating expectations by five cents. However, much of that growth was fueled by big share buybacks. On their own, Time Warner's core businesses posted dismal operating income growth, dipping 5% annually at Warner Bros, falling 15% at Turner, and remaining flat at HBO.
Time Warner still has more catalysts ahead
Time Warner's results weren't terrible, but the stock plunged as much as 10% on Feb. 10 following the announcement. I believe that was an acute overreaction since the company still has several positive catalysts ahead.
First, HBO CEO Richard Plepler noted during the earnings call (as transcribed by Thomson Reuters) that HBO Now had 800,000 paying subscribers. While that missed the more bullish estimates of a million, Plepler noted that HBO Now hadn't launched yet on the PlayStation and Xbox (which account for 20% of HBO Go's audience), and that it hadn't "put out content like Jon Stewart, Bill Simmons, Vice daily news show" yet -- which will be "particularly suited for those platforms".
Second, Time Warner CEO Jeff Bewkes pointed out that CNN was making a strong transition to digital platforms, "especially in mobile -- domestic and international." Plepler and Bewkes' comments indicate that fears about cord cutters gutting Turner and HBO's businesses might be overblown. Bewkes also dismissed the idea of an HBO spin-off, stating that "the combined scale of our businesses is critical."
Warner Bros.' theatrical revenue should also bounce back this year with the birth of its DC Cinematic Universe. Batman v. Superman: Dawn of Justice and Suicide Squad, which will be respectively released this March and August, will expand the universe that was established in 2013's Man of Steel. If Time Warner can replicate Disney's (NYSE:DIS) success with the Marvel Cinematic Universe, its current problems of poor year-over-year comparisons could become a distant memory. The November release of J.K. Rowling's Fantastic Beasts and Where to Find Them can also generate some Harry Potter-like numbers again for Warner Bros.
Lastly, Time Warner raised its quarterly dividend by 15%, which gives the stock a forward annual yield of 2.6%. That compares favorably to Disney and Fox (NASDAQ:FOX), which respectively have forward yields of 1.6% and 1.2%. Time Warner also authorized a new $5 billion buyback program, which should boost its EPS and tighten up its valuations.
But is the stock cheap?
Time Warner now trades at 14 times earnings, which is much lower than Disney's P/E of 17, Fox's P/E of 22, and the industry average of 21 for diversified entertainment companies. Time Warner stock is also fairly cheap compared to its free cash flow growth. The company's price-to-FCF ratio is currently at 15 -- its lowest level in over three years. Disney and Fox have price-to-FCF ratios of 23 and 19, respectively.
Looking ahead, analysts expect Time Warner's earnings to grow 16% annually over the next five years. That gives Time Warner a 5-year PEG ratio of 0.8. Since a PEG ratio under 1 is considered undervalued, the stock looks cheap based on its earnings growth potential. Disney and Fox have respective PEG ratios of 1.4 and 0.8. Based on these three metrics, Time Warner looks much cheaper than its industry peers.
But should you buy Time Warner now?
Time Warner looks cheap, but I think the bearish sentiment regarding media companies could keep weighing down the stock. The stock could still decline further, but I believe that its downside should be limited by its dividend and valuations. Therefore, investors who believe that Time Warner's theatrical lull is temporary and that its cable networks will successfully transition to digital platforms should consider starting a small position at current prices.
Leo Sun owns shares of Walt Disney. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool recommends Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.