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DirecTV: Risks Remain, but Profits Are Growing

February 24, 2014 | About:
Victor Selva

Victor Selva

9 followers

Fighting for customer a solid customer base is one of the largest challenges among any pay TV provider in the industry. However, for satellite TV operators like DirecTV (DTV) this trial is even more difficult, given consumers' rapidly changing viewing habits. Furthermore, the company’s expansion strategy into the emerging Latin American market is supposed to be a source of growth, but some issues regarding subscriber declines in Brazil and a 70% overall decline in the region's subscriptions could be detrimental for profits this upcoming 2015.

Nevertheless, the company’s 93,000 new domestic customers added in fourth quarter fiscal 2013 has helped improve overall results, boosting revenue by 7.7%, and allowing for margin expansion despite continued programming cost pressure. On another positive note, the TV provider has been generous with shareholders, returning $4 billion via share repurchases. However, in spite of the advanced technology and strong brand presence of DirecTV, long-term profits remain uncertain, amid headwinds in the Latin American market, currency fluctuations and changing consumer habits.

In the article below, I will analyze DirecTV's past profitability, debt, capital and operating efficiency, in addition to looking at which institutional investors have recently bought this company’s shares in the last quarter. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings.

Profitability Analysis

Profitability is a class of financial metric used to analyze a business’ ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues, in order to elucidate if the company is really making money.

In addition, I always compare a company's revenue growth and operating cash flow growth. Over the past three years, DirecTV augmented its operating cash flow by 0.7%, from $5.206 to $5.634. I advise to look for companies with strong cash generation profiles.

ROA - Return On Assets = Net Income/Total Assets

This metric gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. I am encouraged by the fact that the firm’s ROA has increased from 12.15% to 15.13% in the past three years, indicating that the company is generating more from its assets than it did in 2010.

Quality of Earnings

Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies -such as inflation of inventory. In order to assess DirecTV's quality of earnings we will compare the level of income with operating cash flows.

The company generated profits growth of 14% over the past two years, surpassing that of the operating cash flow. This implies that earnings could have been created by inventory anomalies.

Working Capital

This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital), while anything over 2 means that the company is not investing excess assets. Therefore, a ratio between 1.2 and 2.0 is believed to be sufficient.

DirecTV’s current ratio (working capital measurement) increased from 0.96 in 2010 to 1.0 in 2012. This shows that the company has a strong balance sheet and can pay off its obligations, leaving it well positioned for investors looking to gain profits.

Rivalry and Moat Rating

DirecTV’s service provision is highly efficient compared to market rivals like Comcast Corporation (CMCSA) or Verizon Communications Inc. (VZ), allowing for returns on invested capital in the 60% range. The firm’s ability to add new customers at a relatively reduced capital expense puts this company ahead of competitors by meeting incremental demand.

As the second-largest pay TV operator in the domestic market, the company faces stiff rivalry from satellite provider DISH Network Corp (DISH), particularly in rural areas where 15 million households lack fixed-line pay TV options. Furthermore, in 2014, the licensed content distribution deal with the National Football League’s Sunday Ticket program expires, leaving the high-rating show open for renegotiation. It’s important to mention that if DirecTV fails to retain the NFL package deal, domestic subscriber rates could fall.

Common Shares Outstanding

I like companies that buy back their own shares, diminishing the number of outstanding shares. DirecTV is one of these companies, as it has been buying its own shares in the past three years, decreasing the number of shares outstanding from 876 in 2010 to 644 in 2012.

Gross Margin: Gross Income/Sales

The gross profit tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors — and overall industry — is more efficient and investors will tend to pay more for these businesses, given their ability to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

Over the past three years, DirecTV’s gross margin has decreased from 49.8% in 2010 to 47.6% in 2012. This decreasing margin indicates that the company has been becoming slightly less efficient year-after-year.

Asset Turnover

Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue — the higher the number the better. It also indicates pricing strategy: Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.

The fact that DirecTV’s revenue growth has outpaced its assets growth (14% growth) on a percentage basis is a positive sign, as it indicates that the company is making money on its assets.

Institutional Sponsorship

I always assume that if a prominent institutional investor put money into DirecTV, the stock will pass strict fundamental standards and bring profits. In this case, prominent investors Joel Greenblatt (Trades, Portfolio) and John Rogers (Trades, Portfolio) added an additional 50% of the company’s shares to its portfolio in the past quarter, at an average price of $63.17.

Analyst Outlook

Nevertheless, many analysts currently have a good outlook for DirecTV. Analysts at MSN Money are predicting that the firm will retrieve EPS of $4.96 for fiscal year 2013 and EPS of $5.77 for fiscal year 2014. Analysts at Bloomberg, on the other hand, are estimating revenue to be at $33.33B for fiscal year 2014, coinciding with the 28.5% reported growth in fiscal 2013. Also, on Jan. 21, 2014, Jefferies gave DirecTV a rating of "buy" with a target price of $73.89, signifying strong upside potential from this point.

To Buy or Not to Buy

At this point, DirecTV is producing solid results on many levels, including its asset turnover, working capital, revenue growth and returns on assets. The 68.90% EPS growth rate is also tempting, especially considering the company’s year-over-year EBITDA growth of nearly 30%.

However, in the long term, the satellite TV operator faces stiff competition from regional providers in Latin America, and considering this market is the main growth driver in management business model, this could become a complicated scenario. Nevertheless, with the stock trading at 14.40x trailing earnings, in a price discount relative to the industry average of 16.60x, this might be the best time for investors to buy shares, before the price goes up.

Disclosure: Victor Selva holds no position in any stocks mentioned.


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