WWE May Wrestle With Poor Earnings Quality

| About: World Wrestling (WWE)


In February, WWE launched a 24/7 channel to showcase its programming, charging just $10 per month.

WWE’s earnings quality, based on the StarMine Earnings Quality model score of 5, look like profits may not be coming from sustainable sources.

Falling margins and weak free cash flows may lead to unsustainable earnings at WWE.

World Wrestling Entertainment Inc. (NYSE:WWE) has built its World Wrestling Federation into one of the most successful entertainment brands ever, featuring such beefy stars as Hulk Hogan and Rowdy Roddy Piper. CEO Vince McMahon is as famous as some of his stars. In recent years, he's changed the company's focus from kid-centric products to those that appeal to adults and built nearly $660 million in revenue (2013) on pay-per-view. However, a new strategy may prove to be a bigger challenge than facing Gorilla Monsoon in the ring.

In February, WWE launched a 24/7 channel to showcase its programming, charging just $10 per month. That is a big move for a company that relied on pay-per-view. The Thomson Reuters research team took a look at WWE's earnings quality, and based on the poor StarMine Earnings Quality (EQ) model score of 5, it looks like profits may not be coming from sustainable sources. Let's see why.

Margins are on the mat

As you can see in the chart above, operating profit margin at WWE has been falling steadily for the last three years and is now 4.1%, much lower than the industry median of 16.5%.

Just three years ago, operating margins at WWE were above the industry median, peaking in March 2010 at 19%. Falling margins have to be a concern for WWE. The return on net operating assets, which is a measure of how efficiently the company is operating, has also been falling in the same period, falling to 12% now from a peak of 70%. This measure is also below the industry median and is a sign of management's inefficiency in generating returns on its assets.

Cash flow in a headlock

The company has seen poor free cash flows in the last five quarters. Despite posting positive earnings in each of the last five quarters, cash flow has been negative in three of the five quarters. Weak cash flows are a sign of poor earnings quality and while the company has made investments to set up the 24/7 video channel, it remains to be seen how much this will cannibalize the pay-per-view revenues of WWE. While WWE content remains popular, there is increasing competition from other programming like Ultimate Fighter, and it remains to be seen if WWE can continue to draw audiences with new content.

Debt allowance on the ropes

One more concern for earnings quality is the falling allowance for doubtful debt over the past three quarters. Management has not addressed the reason for the falling bad debt allowance, which is the amount management sets aside for accounts receivables that it does not expect to collect from clients. Earnings generated because of the falling bad debt allowance tend not to be sustainable in the long term.

WWE generated over 75% of its earnings from North America and is yet to gain as much popularity internationally. While CFO George Barrios acknowledged that WWE was looking to expand its footprint internationally, especially in markets like India, that will likely take some time, and the audience will also be influenced by other competing products. It's not clear if consumers in those regions will be willing to shell out the money for the content, given that many did not grow up on a steady dose of wrestling. The poor earnings quality at the company may mean that earnings in the coming quarters will be down for the count.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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