Piper Jaffray published a report on Sirius XM Radio (SIRI) on 26th September; Piper Jaffray analyst James Marsh raised FY 2014 revenue estimates from $4,043 million to $4,180 million and EBITDA estimates from $1,492 million to $1,563 million. Piper Jaffray has also revised the target price from $4.5 to $5. I aim to study whether the company's recent performance and its fundamentals support these target revisions or not?
Sirius's primary source of revenue is subscription fees. Most of its customers subscribe on an annual, semiannual, quarterly or monthly basis. It also offers discounts for long-term subscription plans as well as discounts for multiple subscriptions. Other sources of revenue include the sale of advertising on select non-music channels, the direct sale of satellite radios, other subscription-related fees, and sales from components and accessories. It also includes other ancillary services such as its internet radio, data and weather services.
Overall, the company's performance on a standalone basis has improved in almost every aspect in the second quarter of fiscal year 2013 in comparison to the same quarter of fiscal year 2012. Cost of revenue also increased to a higher percentage. The gross margin of the company decreased slightly in the most recent quarter of fiscal year 2013 compared to the corresponding quarter of fiscal year 2012.
Although operating expenses increased in the latest quarter of fiscal year 2013 when compared to the reports of previous years it becomes obvious that these expenses had decreased by 1.43% as a percentage of revenues. The company's operating income increased by 17.54% to $268 million during the second quarter of the current fiscal year compared to the same quarter of the previous year. Due to an increase in the operating income, operating margins of the company improved by 1.30% during the most recent quarter of fiscal year 2013 compared to the corresponding quarter of the 2012 period.
Apart from revenues, Sirius performed above industry averages in almost every aspect. Revenues of the company grew with a CAGR of 11.20% over the last three years compared to the industry average of 15.80% during the same period. The company reported an operating margin of 26.70%, in the last 12 months, which is higher than the industry average of 17.70%.
Moreover, the company's net margins were almost double the industry's average net margins over the last 12 months. Sirius's debt/equity ratio is 0.9, which is well below the industry average of 1.4. Despite having financial leverage the company's ROE is 13.20%, which is higher than the industry average of 9.20% over a period of 12 months. A higher ROE was attributed to the higher net margins of the company.
Industry Outlook & Growth Prospects
The upturn in the advertising business should deliver solid growth to the industry. Global radio revenues are expected to grow to $51 billion, at a CAGR of 3% over the next five years. Revenues are expected to grow slower in North America.
In terms of revenues and technologies North America and Europe are the most developed global radio regions. These two regions combined accounted for 78% of all global radio revenue in 2012. According to a research report the contribution to revenue for these two regions will decline slightly to 74% until 2017.
North America should continue to account for almost 50% of all global radio revenues by generating $24 billion in 2017. Despite having innovative business models and the latest technology, North America and Europe's market shares will decline slightly over the next five years.
Last year, radio revenues in the US were around $20.70 billion. Satellite subscribers will be the key drivers of radio revenue growth over the next five years. Satellite subscriptions are expected to grow with a CAGR of 7.6%, compared to a modest 1.40% CAGR for radio advertising revenues. US satellite radio subscribers generated almost $3 billion in radio revenue in 2012.Satellite radio's growth is expected to increase from 15% of all US radio revenue last year to 20% by the end of 2017. Overall, radio revenues have rebounded after a sharp decline to $17.8 billion in 2009. However, revenues are not expected to reach the level it achieved in 2008 until 2016.
According to financial reports, Sirius has agreements with every major automaker to offer satellite radios as factory or radio installed equipment in their vehicles. Sirius acquires a majority of its revenue from such deals with automakers. Auto sales have increased in the US. In August, auto sales have grown at a rapid pace since October 2007 and rose by 17% during the last month. This is a good sign for automakers and Sirius, which generates a major portion of revenues from automakers.
Multiple Based Valuation
Average Case Scenario:
Sirius's price to earnings ratio is better than the industry average. Its current price to earnings ratio is 55.6 times which is lower than the industry average of 71.4 times. Therefore, I can conclude that the stock is undervalued on a P/E basis. However, all other multiples of the company are higher than the industry average, which indicates that the stock is overvalued. I have assigned 35% weight to each ratio of price to earnings and price to cash flows while 15% weight is assigned to each ratio of price to book value and price to sales. As shown in the following table, fair value of the stock is $4.34 which gives an upside potential of 9.11%.
Since the company's price to earnings ratio is better than the industry average I have assigned more weight to the price to earnings ratio in the best case scenario. The weights of other multiples have decreased. As shown in the following table, fair value is $5, which is 25.72% higher than the current price of the stock.
Worst Case Scenario:
By giving less weight to the price to earnings ratio, fair value of the stock in the worst-case scenario is $3.59, which is 9.78% lower than its current stock price.
Sirius's performance was better on both a standalone basis and an industry comparison basis. The company's operating income and operating margin increased significantly in comparison to its performance in the second quarter of fiscal year 2012.
Sirius's revenues are dependent upon the auto industry as it is the leading generator of revenue. The recent recovery of the economy and rising sales of automobiles should give a boost to the revenues of the company.
Fair value of the stock is $4.34, which is 9.11% higher than the current stock price. Moreover, the stock has an upside potential 25.72% while the downside potential is 9.78%. Therefore, on a valuation basis, I would recommend buying the stock.