I am recommending stock in Entercom Communications Corp. (ETM), on the grounds that they are considerably undervalued. Of course, I wish I had issued this recommendation last week when they closed at $5.29 per share, but even now that they are at $7.30 per share, the company is still compellingly undervalued.
Entercom claims to be "one of the five largest radio broadcasting companies" in the United States, which I take to mean that they are the fifth largest. Like so many companies, they recognized large impairments of their intangible assets in 2008 and 2009, which made earnings look absolutely horrible for those two years. However, such impairments are a noncash expense, and based on the firm's actual free cash flow, Entercom produced, and continues to produce, a very attractive return based on the current share price.
In 2008, for example, the firm booked an operating loss of $710 million. However, $835 million of that loss was due to a large impairment; without that, the firm would have produced operating income of $125 million. After removing $45 million in interest, and applying a 35% tax rate, we get $52 million in sustainable earnings. For 2009, when advertising revenue had dropped somewhat from 2008, the firm reported operating income of $11 million, but that was after an additional $68 million noncash impairment, and as adjusted the firm produced $79 million in operating income.
After removing $31 million in interest (much of Entercom's financing is from variable rate debt) and applying a 35% tax rate, we get $31 million in sustainable earnings. For the first two quarters of 2010, advertising revenues have rebounded a bit as compared to the first half of 2009, producing operating income of $41 million, and no impairments at all, finally. After $14 million in interest, and applying a 35% tax rate again, we get earnings on a sustainable basis of $17.5 million, or $35 million projected for the entire year. Since the company at the current price has a market cap of $260 million, this produces a P/E ratio of 7.5.
If, however, we investigate issues of free cash flow, the situation improves further. In 2008 Entercom took a depreciation and amortization allowance of $20.5 million, but made capital expenditures of only $8.5 million. In 2009, their depreciation allowance was $16.5 million, but they made only $2.5 million in capital expenditures. And in 2010 year to date, depreciation ran $6.5 million, but capital expenditures have run only $1.5 million. So, it would seem, if current levels of capital expenditure are deemed adequate, that the firm has an additional $10 million in annual free cash flows at least, which would give it projected 2010 annual free cash flow of $45 million, and a price/free cash flow ratio of 5.75.
Furthermore, Entercom, according to its latest 10-K, had a net operating loss carryforward of $48 million as of December 2009, which should serve to shelter their income from taxes for all of 2010 and possibly part of 2011 as well. This would save the company $16.8 million dollars.
I will admit that Entercom's balance sheet is looking more than a little anemic; the stated value of their assets, owing to the massive impairments, is $913 million, and they have $777 million in total liabilities, producing shareholders' equity of $136 million. However, I believe that these impairments were overstated, because I find it hard to believe that $136 million in assets (actually, 114 million at the end of year 2009), can produce free cash flows of $45 million; that's a return on equity of roughly 33 percent which strikes me as unusually high.
Furthermore, in terms of interest coverage, the company seems to be doing adequately: 2.75x in 2008, 2.5x in 2009, and 2.9x year to date 2010. This figure approaches the 3x coverage that I use as a rule of thumb to allow debt to appear reasonably safe. As I stated, though, much of Entercom's debts are variable rate. On the plus side, Entercom has interest rate derivatives to prevent them from rising interest rates in the notional amount of $475 million, roughly 2/3 of their total long term debt.
On the plus side, Entercom has been paying down their debt at a fairly rapid pace, $76 million in 2009 and $35 million in 2010 to date. And, realistically, given the current environment I don't see interest rates rising by much any time soon.
So, despite the 38% run-up in a week that I missed (I'm sorry), I think that Entercom is still dramatically undervalued.
Disclosure: No positions