Key Metrics: WBD is trading at 7 times earnings, 0.56 times sales,and 2.86 times free cash flow.
These are extremely low multiples and are usually seen in companies with decreasing revenue, companies with tremendous headwinds, or in certain industries like the auto industry. Lets compare WBD metrics to a direct competitor like PARA (Paramount Global).
We can see that the multiples are similar, except that PARA had negative Free Cash Flow in the trailing 12 months while WBD was positive. So low multiples could be industry wide but we will see more specifically why the multiples might be so low when we get to the debt levels. But first, let’s see what their revenue and profit growth looks like.
Revenue and Profit Growth: From the chart below we can see that their revenue growth fluctuates but overall it is a pretty decent uptrend, while their profit levels haven’t really seen the same increase at all.
Looking closer at the graph above we can see a large increase in fiscal year 2018 revenue. An abnormal increase like this makes me think this was fueled by an acquisition and wasn’t organic revenue growth so let's look at the cash flow statement on our software.
As we can see they made a huge acquisition that year which would explain the increase in revenue. Keep this acquisition in mind when we look at debt levels as well. So now that we have a better picture of their revenue growth, we can see it is a lot more modest than it seems at first glance. But, as WBD ramps up their streaming services we could see more steady revenue growth in their future.
Free Cash Flow and Long Term Debt: Now we get to what I consider to be the most important aspect of any business, their free cash flow. As you can see in the graph below, WBD does have pretty significant free cash flow, and in fact it is significantly higher than their profit levels which is likely due to accounting tactics after their acquisition since profit and free cash flow levels were extremely similar before the major acquisition in fiscal year 2018.
Over the next few years we would like to see profit levels reported rise to match the free cash flow levels as they should. Another thing we would like to see is WBD using their free cash flow to pay down that long term debt. As you can see their debt increased around 7 billion dollars in 2017 right before their big acquisition of around 8.5 billion dollars. Luckily, management has said one of their main focuses is paying down that debt. We would like to see their debt get down to below 4-5 times free cash flow levels. I think that if they continue to pay down debt and get it to a reasonable level, they may even start to issue a dividend which can be a nice reward for shareholders as long as the company has the free cash flow to support it. Next we will look at the shares outstanding, a crucial thing to look at when analyzing a company.
Weighted Shares Outstanding Diluted: From the graph below you can see that the weighted shares outstanding diluted are all over the place, but are down from 10 years ago. We want to see the shares outstanding decreasing as this means you own more of the company without buying additional shares yourself as a shareholder. This is another way companies can reward their shareholders. (I clicked off weighted shares outstanding on the graph below to make it easier to see the trend).
Weighted shares outstanding diluted include all the convertible securities in the calculation. This includes stock based compensation. This is important to note because when we look at the cash flow statement on our software we can see that they haven't issued shares since 2017 and even then what they were issuing was such a small amount compared to the amount that they had been repurchasing. So we look to the stock based compensation row to see if that was what causing the fluctuations and it seems to be. We can see this in the picture below, keep in mind the values are the dollar amount of the shares not the amount of shares and I have put a red box around the rows in question for convenience.
Valuation: So taking all this into account we can assume that the low multiples in the industry are largely due to the debt levels. Let's figure out what we think might be a fair value for the stock today in a bear, base, and bull case scenario.
Bear Case: In the bear case we assume 0 revenue growth for the next 10 years which gives us a terminal revenue of about 12.6 Billion. We assumed an average profit and free cash flow margin of 8% and ending PE and PFCF multiples of 8 as well.
Base Case: In the base case we assume 2% revenue growth for the next 10 years which gives us a terminal revenue of about 15.3 Billion. We assumed an average profit and free cash flow margin of 10% and ending PE and PFCF multiples of 10 as well.
Bull Case: In the bull case we assume 4% revenue growth for the next 10 years which gives us a terminal revenue of about 18.6 Billion. We assumed an average profit and free cash flow margin of 12% and ending PE and PFCF multiples of 12 as well.
For all of our cases we used a required rate of return of 15%. The reason for this is that the S&P500 averages about 10 percent so to take on the risk of holding an individual company, especially one with such high debt levels, we require a higher rate of return.
Fair Value and 10 year price targets:
The fair value we got for our bear case was $10.60 with a 10 year price target of $27.28.
The fair value we got for our base case was $16.09 with a 10 year price target of $44.24.
The fair value we got for our bull case was $23.61 with a 10 year price target of $68.75.
Using our new Stock Analysis Dashboard, you can analyze any stock in the market and even calculate your own price targets! The dashboard is extremely useful for looking at a company’s fundamentals so you can determine whether or not to buy their stock. It’s an amazing tool that the entire StockedUp team uses on a regular basis.
DISCLAIMER: We are not financial advisors. We are just giving our opinions. Everything in this article is for entertainment purposes only. Do your own due diligence before making any trading or investing decisions.