Since so many of us are now in self-isolation or quarantine, shouldn’t the companies that make television shows be booming? Perhaps, but you wouldn’t see that if you checked the price chart of Discovery, Inc. (DISCA, Financial):
One of the results of that declining share price is that Discovery has now made it onto the Undervalued Predictable screener list at GuruFocus. Stocks on this list are selling for less than their intrinsic value, and they have a history of delivering consistent returns to shareholders. Both of those are critical variables for value investors. However, the past is not a guarantee of future resutls. Is Discovery able to live up to its history?
Discovery is the company that creates and distributes television and streaming programs. It provides this list of its programs on its website: “Discovery Channel, HGTV, Food Network, TLC, Investigation Discovery, Travel Channel, Motor Trend, Animal Planet, and Science Channel." It also owns the Oprah Winfrey Network in the U.S., Discovery Kids in Latin America and Eurosport, the leading provider of locally relevant, premium sports and home of the Olympic Games across Europe.
Note the last listing, Eurosport and the Olympic Games. Since the 2020 Summer Games have been bumped to 2021, that hurts Discovery’s upcoming financial results and is one of the reasons for a struggling stock price.
Also important in the short term is the overall bear market for advertising. The New York Times recently reported that advertising is in decline as the economy contracts. It noted that travel and entertainment ads have just about disappeared from Google, while Facebook ad prices have dropped between 35% and 50% in recent weeks. Other media likely will be hit even harder.
To determine Discovery’s merit as an investment, I have turned to the Macpherson model, which will help us get quick answers to several critical questions:
- Does the company have a moat, a competitive advantage that gives it pricing power, above-average margins and higher earnings?
- Is it financially strong?
- How profitable is it?
- Is it priced well below its intrinsic value?
Note that this valuation model is extremely conservative.
Moat
The model uses two criteria to determine if a business has that important advantage:
- Return on capital (ROC): Discovery has an ROC of 11.9%, below the 15% required by the model.
- Return on tangible equity (ROTE): The company has negative tangible equity, which means intangibles such as trademarks, patents, goodwill, etc. are greater than its total stockholder equity. Again, the model calls for a 15% threshold.
According to this technical model, there is no moat or sustainable moat in Discovery's case, despite the prominent brands it owns or controls.
Financial strength
Here, the Macpherson model calls for a GuruFocus financial strength rating of at least 9 and a Cash-to-Debt ratio of 100. As this screenshot makes clear, Discovery fails on both counts:
Profitability
Referring to the table above, we can see it meets the threshold for profitability, with a rating of 9 out of 10. Scrolling down the column we see supporting details:
- An operating margin of nearly 29% and a net margin of more than 18.5%.
- An ROE (return on equity) of 16.6%.
- Three-year average growth rates of more than 13%.
We can pass Discovery on profitability.
Undervalued
Discovery is significantly undervalued, based on the current market price and the intrinsic value estimates established with the discounted cash flow calculator. These fair prices can be calculated on a free cash flow basis or an earnings basis:
- Free cash flow: The market price at the close of trading on April 14, 2020 was $22.30, while the free cash flow calculator puts the firm’s value at $125, for an 82% discount.
- Earnings: The discounted earnings calculator values Discovery at $31, far below the value reached with the discounted free cash flow calculator, but still above the market price and providing a 28% margin of safety.
GuruFocus reports that an earnings approach is the preferred valuation method for Discovery. Given the market price is 28% below the intrinsic price, we can give the company a passing mark for being undervalued in terms of profitability.
Ownership
Discovery is held by nine of the gurus followed by GuruFocus. On the last day of November 2019, Smead Value Fund (Trades, Portfolio) held more than 2.5 million shares, while on Dec. 31, Mario Gabelli (Trades, Portfolio) held more than 1.1 million shares and Pioneer Investments (Trades, Portfolio) held 672,000.
Of the gurus’ last 10 trades on the name in 2019, six were reductions or sell-outs and four were new buys or additions.
Institutional investors hold 22.87% of the shares outstanding, while insiders own 3.2%. Among the insiders, CEO David Zaslav held the most shares, almost 3 million, while John Malone held just under 800,000 and Bruce Campbell held 423,000.
Discovery does not pay a dividend, nor has it repurchased its own shares in the past three years.
Conclusion
Discovery, Inc. is on the list of Undervalued Predictable stocks, meaning it is priced below its intrinsic value according to the screener's metrics and has a history of consistent shareholder returns.
There are likely better choices available to value investors. Discovery does not have a moat, and its financial strength is sapped by debt. However, it is a winner on profitability and is currently a bargain stock. Given the number of companies now available at discount prices, I believe there is good reason to look beyond Discovery.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
Read more here:
- Hanesbrands: Big Bargain, Big Debt
- Book of Value: Buffett, IBM and the Refutation Process
- Book of Value: Adding Growth to a Defensive Portfolio
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