One of the reasons our members love us is that we tell the story through the numbers. Every income statement says something; every balance sheet has a history; and every cash flow statement reveals a firm's true intrinsic value. The numbers talk--and we think every investor should listen to them. Let's see what they say about Comcast (CMCSA).
For those that know us, we think a comprehensive analysis of a firm's discounted cash-flow valuation and relative valuation versus industry peers is the best way to identify the most attractive stocks at the best time to consider buying. This process culminates in what we call our Valuentum Buying Index (click here for an in-depth presentation about our methodology), which ranks stocks on a scale from 1 to 10, with 10 being the best. It's a robust process, but also very simple one to interpret.
For example, if a company is undervalued both on a discounted cash-flow basis and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. The higher the better. Comcast posts a VBI score of 6 on our scale--this reflects our 'fairly valued' DCF assessment of the firm, its unattractive relative valuation versus peers, and bullish technicals. For our relative value assessment, we compare Comcast to peers DIRECTV (DTV), Time Warner Cable (TWX), and Viacom (VIA).
- Comcast is a global media and technology company that presents its operations in the following five reportable business segments: Cable Communications, Cable Networks, Broadcast Television, Filmed Entertainment, and Theme Park. Comcast's 'Cable Communications' business generates most of its EBITDA (more than 80% in 2012).
- The company's cable offering, Comcast Cable, is the U.S.' largest provider of video, high-speed Internet and voice services to residential customers under the XFINITY brand. We like the scale and cash-rich nature of its cable operations.
- Comcast has a good combination of strong free cash flow generation and manageable financial leverage. We expect the firm's free cash flow margin to average about 19.1% in coming years. Total debt-to-EBITDA was 1.4 last year, while debt-to-book capitalization stood at 45%.
- Although we think there may be a better time to dabble in the firm's shares based on our DCF process, the firm's stock has outperformed the market benchmark during the past quarter, indicating increased investor interest in the company.
- The firm experienced a net income CAGR of about 19.5% during the past 3 years. We expect its net income growth to be better than its peer median during the next 5 years.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (OTC:WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Comcast's 3-year historical return on invested capital (without goodwill) is 8.5%, which is below the estimate of its cost of capital of 9.2%. As such, we assign the firm a ValueCreation™ rating of POOR. Hard to believe, but this is what the numbers say. We show how we calculate the measure in the Comcast report on our website. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Comcast's free cash flow margin has averaged about 15.5% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website. At Comcast, cash flow from operations increased about 12% from levels registered two years ago, while capital expenditures expanded about 21% over the same time period.
Our discounted cash flow model indicates that Comcast's shares are worth between $36-$58 each. Why such the large range? Call it prudence. Call it experience. Call it an understanding that a fair value estimate is not a point estimate. But one thing you won't call it is: overconfidence, one of the biggest pitfalls an investor can make. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $47 per share represents a price-to-earnings (P/E) ratio of about 20.6 times last year's earnings and an implied EV/EBITDA multiple of about 5.5 times last year's EBITDA. We think this is fair. Our model reflects a compound annual revenue growth rate of 3.6% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 20.5%. Our model reflects a 5-year projected average operating margin of 22.6%, which is above Comcast's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 4.2% for the next 15 years and 3% in perpetuity. For Comcast, we use a 9.2% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $47 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Comcast. We think the firm is attractive below $36 per share (the green line), but quite expensive above $58 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Comcast's fair value at this point in time to be about $47 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below ompares the firm's current share price with the path of Comcast's expected equity value per share over the next 3 years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares 3 years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $61 per share in Year 3 represents our existing fair value per share of $47 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements