Comcast: An Industry Leader Poised to Expand Its Advantage

June 18, 2015 |

Comcast (CMCSA) has four long-term advantages over its competitors: a faster growing broadband customer base, metric tonnes of free cash flow, a relatively healthy balance sheet, and its revenue stream from NBCUniversal. I think these four advantages will lead to strong long-term results for the company, and their plan to spend $6.75 billion on repurchases this year will lead to further growth in the stock price. At a Price/Earnings ratio of 18.3, they’re affordably priced.

Let’s start by breaking down some of Comcast’s key numbers vs. the Pay TV industry and the S&P 500 with Stock Rover. In the table below, Comcast’s numbers are in the ‘Stock’ column.
Comcast

We see some signs of Comcast’s outperformance here, both vs. the industry and the S&P. Most important is Comcast’s recent sales growth of 3.7%, which is coming straight out of competitors’ market share as average industry sales have shrunk 3.2%. Comcast’s valuation is very attractive compared to both metrics, especially their Price/Free Cash Flow of 17.8, since it’s the free cash flow that they can use to reward shareholders or invest in their business. They also are good at what they do: Margins are well above industry average, and their net margin of 12.4% is nearly double the industry’s. Comcast’s returns on capital have also outperformed the industry, and have been increasing steadily for the past five years. See the bottom chart below, showing Comcast’s increasing ROIC, ROA, and ROE over the past 5 years.
Return on Capital

Comcast also benefits from a diversified and growing income stream. In the most recent quarter, Comcast increased cable revenue by 6.3% over last year by increasing revenue per customer by 4.7% and adding 200,000 customers. Their business services segment grew revenue by 20% over last year, and occupies only 25% of the small size market and 10% of the mid-size business market, leaving room for growth. Internet revenue grew 10.7% as Comcast added 407,000 broadband customers in the first quarter. Comcast also enjoyed growth from NBCUniversal, a diversified media empire in its own right, especially from the success ofFifty Shades of Grey and Harry Potter theme park in Orlando. The only segment that was down was phone service, which declined 1.5%.

While some analysts may fear that demographic trends and technological advancements will hurt cable companies, I think Comcast is well-positioned to adapt to this trend. The bearish argument goes that millennials won’t pay for the triple bundles their parents bought, and streaming services and the proliferation of screen types will cut into TV consumption.From their most recent earnings call, I think Comcast’s management is aware of this, and they can adapt. Management believes the X1 cable platform, which includes a DVR in the cloud, will continue to drive cable growth, and they are accelerating rollout to a larger percentage of their customer base.

It wouldn’t surprise me if Comcast’s main business shifted from cable to internet at some point in the next decade, and they’re making the investment in faster speeds to keep up with competitors: Comcast’s XFINITY bundle competes directly with AT&T’s Uverse and Verizon’s FIOS. They also have invested in 2 gigabit/second fiber optics for business with big broadband needs, which they will roll out next year. Since internet service is essentially commoditized, consumers are very sensitive to speed, and faster, more expensive plans are higher margin for providers. The company has also created Internet Plus, an internet and limited cable plan aimed at millennials. Their fastest growing segment is their theme parks, and NBC should continue to profit from upcoming classics Ted 2 and Fifty Shades Darker.

All these operations produced $3.2 billion in free cash flow in the most recent quarter, a company record, up 12.7% over last year. $2 billion of that went to share repurchases in the first quarter, and an additional $572 million to dividends. Since Comcast’s payout ratio is only 27.7%, they will likely to continue to increase their dividend, which has grown by an average of 21.5% per year in the last five years, although that rate of growth is slowing. In bigger news, the company plans to increase its return of capital to shareholders by 40% this year over last, mostly by repurchasing $6.75 billion of stock. Comcast is a very big company with a very large market cap, but that’s still an absolute ton of money.

Where these numbers start to look even more impressive is in comparison with Comcast’s competition. Comcast has the highest free cash flow as a percentage of sales of the companies I’ve selected (see below table), which gives it a major advantage when it comes time to invest in infrastructure. The only company on the list that generates more free cash flow than Comcast, AT&T (T), has an unsustainably high dividend payout rate, is focused on acquisitions in other areas, and more debt than Comcast.

Comcast vs. Competitors

Most broadband providers are seeing a larger percentage of their customer base adopt faster, higher margin broadband plans. Where I think Comcast really differentiates itself is in net broadband adds. AT&T reported net adds of 70,000 last quarter, Verizon (VZ) 41,000, Time Warner Cable (TWC) 315,000 and Charter (CHTR) 125,000 to Comcast’s 407,000. To be clear, I’m not arguing that Comcast is going to drive all its competitors out of business. But I do see their already strong market position staying strong, and likely becoming stronger.

While Comcast’s balance sheet has a couple of blemishes, it looks strong in comparison to, say, Verizon or Charter. Their CFO said they were meeting their leverage target and “playing offense” with their balance sheet. Considering their high cash flow, the company’s debt/equity ratio is safe enough at 0.9, though they are laden with $43 billion in long term debt, paying $650 million a quarter in interest. Their Altman Z-Score, designed to measure the chance a company will go bankrupt, is a less-than-stellar 1.7. However, that number has improved over the past few years (see the blue section below—more recent numbers are at the top), and is better than much of Comcast’s competition, as seen above.

Also to their credit, Comcast scores an 8 out of 9 on the Piotroski financials test. Given Comcast’s diversified income stream and massive free cash flow, I’m not too concerned about the company’s ability to meet their obligations and make key investments in their business.

A look at the company’s P/E history suggests now might be a good time to buy. In the chart below, we see that Comcast’s P/E is almost as low as it was two years ago, when shares were $20 cheaper and earnings/share were $0.15 smaller. I think Comcast’s continued earnings growth can push share prices higher, and if investors come around to higher P/E multiples, that could mean even larger share price gains. Their Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization, which measures a company’s hypothetical takeover price to their earnings, has been pretty consistent over the past few years. However, at 8.3, it is significantly better than the industry average of 9.7.
Comcast PE

Conclusion

I see Comcast as attractively priced and well-positioned to meet future industry trends. The company possesses a growing, diversified income stream, and their fiscal strategy seems aggressive and well-considered. Management have been good stewards of capital and are committed to rewarding shareholders.





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