The outdoor advertising industry in the U.S. is dominated mainly by three major companies, which generate 75% of all billboard revenue. However, only one of these companies, Lamar Advertising Co. (LAMR) focuses on midsized markets, where it holds a 70% market share. As such, the firm operates 150,000 billboards, 100,000 logo advertising displays and over 27,000 transit displays throughout the country, which account for a total of 75% of sales. Last quarter, investment gurus Chuck Akre (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio) bought this company’s shares at an average price of $48.8. Let’s see why.
Of Market Advantages and Innovation
While Clear Channel Outdoor Holdings Inc. (CCO) and CBS Corporation (CBS) earn their profits via advertising in large cities, and other major markets, Lamar’s focus is on smaller towns and the midsize market. In addition to assisting customers in the creation and installation of billboards, the company also collects a fee in exchange for providing advertising space to local businesses. But the main benefits derive from the billboard sales themselves and it’s in this area where management has been focusing its recent efforts. While static billboard sales remained somewhat flat during 2013, the firm’s new strategy rollout of digital billboards is bound to boost profits in the long term. Since digital billboards can be changed in a matter of minutes, advertisers can pick specific time during the day when they want their messages projected, which in return will allow Lamar to charge a higher rate during peak traffic times, thus rolling in profits.
Furthermore, the firm benefits from the limitations imposed by the Highway Beautification Act of 1965, earning it pricing power, as well as generous profitability in terms of EBITDA, which exceeded 40% of sales over the past five years. On another note, Lamar is currently in the process of converting to a real estate investment trust, and if the private letter ruling from the Internal Revenue Service is obtained (which management announced is almost a “done deal”), then several benefits will arise. Not only will the REIT structure provide a tax shield in the form of a dividend, but the firm will also enjoy a higher multiple assigned to its cash flow. However, the ultimate value will still depend on growth levels achieved via static and digital billboard advertising.
Although Lamar’s debt load of $1.8 billion significantly limits the company’s financial flexibility, its business model is relatively stable and is sure to bring profits looking forward. While quarterly EBITDA was reported at a solid $138 million, with an annual growth rate of 5.10% during 2013 and operating margins grew at an above average 18.4%, revenue remained flat year-over-year. The quarter closed at $320.4 million, with fiscal 2013 showing a slow 3.1% growth rate. However, management attributed the lackluster growth to shabby weather conditions in the Northeast and slow holiday sales, so the scenario is bound to change come the springtime. In fact, the five-year forecast expects average annual sales growth to be 4.5%, due to price increases and higher occupancy rates.
Despite Lamar’s dependency on the domestic economy and possible interferences from local governments regarding the digital billboards, given safety concerns, I feel bullish about this advertising firm’s future. With free cash flow levels growing consistently since 2011 (they jumped from $211 million to $289 million in merely two years) and 18.9% ROIC, I believe shareholders will benefit in the long term from this company’s dominance in the midsize market. However, the stocks trading price of 128.10x trailing earnings indicates that it is vastly overvalued at the time, compared to the industry average of 20.20x. Therefore, investors may want to wait a little until the price settles before buying this company’s shares.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.