About a year ago, I wrote an article for these pages extolling the virtues of Scripps Networks Interactive (SNI). The share price of the company has appreciated about 23% since then. At the time, our thesis was that SNI was an attractive investment based on valuation, growth potential, profitability, strong free cash flow and a shareholder friendly management. I think it appropriate to re-evaluate this thesis and see if it is still valid.
SNI is a developer of content for the internet and television. There particular niche is lifestyle-oriented programming. The company's content can be seen in 170 countries across the globe. Their brands include HGTV, Food Network, Travel Channel, DIY Network, Cooking Channel and Great American Country.
The Food Network features superstars such as Emeril Lagasse, Rachel Ray, Bobby Flay and the fallen angel Paula Deen. On HGTV, we find the popular shows of House Hunters, Love It or List It and the Property Brothers.
In the second quarter ending 6/30/13, revenues grew 11% to $65.1 million from the prior-year period of $601.0 million. Advertising revenue was $462.0 million, up 11% and affiliate fee revenue of $189.0 million, also up 11% year over year.
For the six months ending 6/30/13, total operating revenue was $1,259.5 million, up 10.8% over the prior-year period of $1,136.3 million. Revenues for the trailing twelve months was $2,430.4 million compared to $2,193.5 million year-over-year, or 10.8%
Second quarter net income was $1.08 per share or $160.0 million compared to $$0.93 or $142.0 million in the second quarter of 2012. For the six month period, net income was $1.80 per share compared to $1.66 in the prior year period. Per share net income for the trailing twelve months was $4.60 as compared to $3.14 year-over-year.
The company provides full-year guidance for 2013. They expect a total revenue increase of 9.0% to 10.0% and non-controlling share of net income of $175.0 million to $185.0 million.
It is instructive to evaluate SNI both on its own and in comparison with other content providers. I chose these particular companies because they seem to me to be the most comparable. Readers may suggest alternatives to this short list.
This chart contains those quantitative metrics I consider most important in making an evaluation. The list balances income statement and statement of cash flow metrics to measure profitability and valuation.
Starting with valuation, we can see that none of these companies is trading at an Enterprise Value to Earnings, Before Interest, Taxes, Depreciation and Amortization (EV/EBITDA) ratio higher than 8X. This suggests that this segment is under-valued. Free Cash Flow to Price or FCF yield is another way of determining valuation. I believe that strong free cash flow is essential for every business so I want to see a FCF yield greater than 6.0%. Another way of looking at this is that I want a Price to FCF ratio of less than 16.67X.
It is great when a company reports positive earnings. It is even better when the quality of those earnings can be backed-up by the generation of free cash. Looking at FCF to Operating Income, we can verify if earnings are genuine or come from accounting gimmicks. We look to see that at least free cash represents at least 65% of operating earnings. With negative free cash, Netflix is not a contender. AMC Networks (AMCX) comes close and Crown Media Holdings (CRWN) is far down the list. Again, the winners are SNI and STRZA.
It is not enough for me for a company to be profitable; it needs to be very profitable relative to invested capital. The first metric I use is EBITDA less Capital Expenditures to Invested Capital. In this instance, I look for a ratio of 20 or better. We see that all of the listed companies report strong levels of profitability based on this metric. I want confirmation of this assessment by using Cash Return on Invested Capital. This differs from Return on Invested Capital in that it utilizes free cash instead of earnings. My requirement is for CROI to be above 12%. Netflix fails this test as does CRWN.
Debt is a factor that should not be overlooked. I am less interested in the role debt plays in a company's capital structure than in a company's ability to pay down the debt. I look for a Free Cash to Long-term Debt ratio of 0.5 or greater. Only SNI passes this test.
As a final test, I look for a company trading near the top of its twelve month trading range. This metric prevents me from buying at a low and limits my upside potential. However, it also validates my assessment of the company's prospects and tells me if the market is rewarding shareholders.
Scripps has other positive attributes. The company pays an indicated dividend of $0.60 per yield which represents a yield of 0.8%. In addition, the company has a share buyback program. For the quarter ended June 30th, the company repurchased 1.5 million shares for an aggregate cost of $100 million. The company has $650 million remaining in the $1.0 billion stock repurchase program.
Scripps Networks is an attractive collection of brands. It grows both its advertising revenue and the lucrative affiliate fees. It pays a dividend and buys back shares. Scripps may be considered an attractive acquisition target for a company such as the Walt Disney Company (DIS). When the Edward W. Scripps Trust with 93.5 percent of the voting rights disbanded last year, new opportunities became possible. In my opinion, SNI remains undervalued.