I like to keep a close eye on the developments of the pay-tv industry. Sometimes, I come across interesting investment options, like DIRECTV (NASDAQ:DTV). Although I take many aspects into account when I analyze a company, I will focus, in this article, on debt and liabilities.
I will look into DIRECTV's total debt, total liabilities and debt ratios. In addition, I will examine what analysts and other top investors think about this company. This analysis is crucial to understanding the risks of investing in this company, and will allow us to appreciate how leveraged the company is, and what kind of returns to expect for a long-term investment. As the years 2008 and 2009 have taught us, leveraged companies with large amounts of debt can have a devastating impact over your investment. However, by taking a close look into the debt scheme of DIRECTV, we will be able to elucidate if the company is likely to maintain its capital and use it for future growth.
Total Debt to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It results of adding short-term and long-term debt and then dividing this figure by the company's total assets. If the outcome is higher than 1, it means that a company's total debt surpasses the value of its total assets. On the opposite, a debt ratio smaller than 1 indicates that a company's assets are worth more than its total debt. The total debt to total assets ratio (especially when complemented with other measures of financial health) can come in extremely handy when investors want to determine a company's level of risk.
DIRECTV's total debt to total assets ratio has increased over the past three years from 0.73 to 0.85. This indicates that since 2010, DIRECTV has added more total debt value than total assets, which is not a good signal for bond investors.
Still, given that DIRECTV's ratio of 0.85x is smaller than 1x, the financial risk faced by the company is relatively low: its assets' value comfortably surpasses its total debt levels.
Debt Ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high debt ratio - or that is "highly leveraged" - could be in danger if creditors start to demand repayment of debt.
Over the past three years, DIRECTV's total liabilities to total assets ratio has grown from 1.15 to 1.24. This is usually not a good sign, in my view.
In addition, as the 2013 TTM numbers are above the 0.50 mark, this indicates that DIRECTV has financed most of its assets through debt. As the number has increased, so has the risk of investing in the company.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
DIRECTV's debt-to-equity ratio has fallen over the past three years. In 2012, it acquired a value of 4.71, compared to 6.84 in 2010. This is an encouraging sign, as it shows that the company has ameliorated its balance sheet and risk profile.
The fact that the company's ratio currently surpasses 1x (4.71), indicates that shareholders have invested more than suppliers, lenders, creditors and obligators, which implies a high risk for the company and its stockholders.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky: if they fail to repay their debt on time, jeopardy of insolvency gets high. Companies with an elevated capitalization ratio may also find it difficult to get more loans in the future.
Over the past three years, DIRECTV's capitalization ratio has decreased from 0.81 to 0.76. This implies that the company has more equity compared to its long-term debt. As this is the case, the company has had more equity to support its operations and add growth through its equity. A decreasing ratio - currently at 0.76 - implies a slight reduction in the company's financial risk (which is, actually, quite low).
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. It provides an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
As the ratio stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.
Valuation, Profitability and Growth
Additionally, I will take a look at DIRECTV's valuation, profitability and growth figures in relation to other companies in the industry:
DISH Network (NASDAQ:DISH)
Operating Margin % TTM
Net Margin % TTM
Current valuation seems reasonably attractive. 7% 2014 FCF yield not bad for a stable business with 5-7% organic EBITDA growth and potential upside for cable M&A/consolidation, continued buybacks and pay-TV penetration growth in Latin America. On an EV/EBITDA basis, it's trading at 6.5x compared to 7x past 7-year average and 7.7x peers average (ex-SIRI). Down case scenario looks bad, but seems temporary rather than permanent. Management will keep doing aggressive buybacks and the stock hasn't ever traded below 6x except for the brief period during Sept 2008-June 2009 financial crisis.
Future Buyback Scenario
DIRECTV's management has been buying back shares aggressively, reducing shares outstanding from 1.2b in 2006 to current 573mn (50% shares reduction in 7 years). Management stock option incentives suggest they will continue focusing on repurchases and explained in several quarterly transcripts that they think buybacks are the best way to reinvest capital considering its flexibility and tax efficiency. In the last Investor Day, management guided for $4b in buybacks for 2014 and explained they will keep returning excess cash to shareholders thorough buybacks.This is a very positive catalyst for shareholders.
In the last Goldman Sachs September 25 event, DTV CEO Michael White explained that in the current rising content cost scenario that has a monopolistic structure of content providers but fragmented structure of distributors, a merger with DISH or a consolidation would make a lot of sense. While a potential merger in 2002 failed for antitrust reasons (at that time households had only 3 cable alternatives), the scenario has changed with the increase in number of players. DTV would benefit (at least from a regulatory standpoint) if the CMCSA/CHTR/TWC merger comes to fruition and is approved. Morgan Stanley estimated significant after-tax synergies of $25b in a DISH+DTV NewCo base scenario.
DirecTV's current valuation at 6.5x '14 EV/EBITDA and 12x Forward P/E is too pessimistic considering management 2016 guidance for both EPS and FCF, DTV's core advantages, continued aggressive buybacks and expected growth in Latin America. There is also a considerable valuation gap to US cable peers, which I think should correct. DTV has acceptable downside at current levels and 8-30% upside considering projected buyback scenarios and mid-single digits EBITDA growth rates. While many skeptics have long predicted the demise of the satellite TV players due to the lack of a competitive bundle and Internet-TV proliferation, DirecTV has been proven remarkably resilient.