Comcast's Dividend: Strong Enough To Defy Cord Cutting?

| About: Comcast Corporation (CMCSA)


Comcast continues in the fight against cord cutting by the new age consumer, exemplified by its recent purchase of DreamWorks Animation.

Though cord cutting remains a major concern for all cable providers, Comcast has put up solid results in recent quarters.

The strength of Comcast's dividend comes from the cash-rich nature of its cable business. Its yield is not all that compelling, however.

Let's take a look at the firm's investment considerations as we walk through the valuation process and derive a fair value estimate for shares.

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By The Valuentum Team

Comcast (NASDAQ:CMCSA) continues in the fight against cord cutting by the new age consumer. The firm purchased DreamWorks Animation earlier in 2016 to augment its position in the kids and family entertainment space through its Universal Filmed Entertainment Group. The deal is yet another indication that traditional network-based entertainment companies are looking for other means by which to expand their revenue base. A main factor in the acquisition was Comcast's interest in the potential of theme parks and products associated with DreamWorks' portfolio of films.

Comcast and Disney (NYSE:DIS) are both taking the cord-cutting challenge head-on through online entertainment provider Hulu, which is jointly-owned by the two firms and Twenty-First Century Fox (NASDAQ:FOX). Hulu is developing a subscription service that would rival traditional pay-TV providers, in addition to its on-demand programming platform. The plan for the developing product is to create a personalized experience through a combination of traditional linear TV and on-demand video. Exposure to such an entity offers the traditional TV giants a bit of a hedge against the trend, but it may not be enough.

But how does this cord cutting dynamic impact the yield hungry investors scouring the market for strong dividend payers? Let's take a look. The strength of Comcast's dividend comes from the cash-rich nature of its cable business. The Cable Communications segment accounts for nearly 80% of the company's operating cash flow, and its robust free cash flow generation allows the firm the ability to handle the large debt load that resides on its balance sheet. The company's high-speed Internet operations help mitigate some of the risk that is associated with the cord-cutting movement that has revolutionized how video content is consumed. Though the firm does not have an eye-catching yield (~1.4%), it has grown its payout materially in recent years, and we see no reason why this should not continue.

Comcast has a net debt position of ~$44 billion, and though we feel its free cash flow generation should be able to handle this outsize debt load, it could provide additional pressure if free cash flows waver substantially. There are some secular trends working against the firm's cable operations, but for the time being, the segment is a free cash flow generating machine. Competing capital allocation options could provide a headwind to future dividend growth; debt repayment may very well become a priority as the debt load continues to swell, and share buybacks have been prevalent as of late. We expect Comcast's free cash flow generation will be sufficient in covering all obligations and dividend growth for the foreseeable future. We've covered its dividend prospects, but now let's change channels as we dive into the remainder of its investment thesis.

Comcast's Investment Considerations

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Investment Highlights

• Comcast is a global media company that presents its operations in the following five 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%). It was founded in 1963 and is headquartered in Philadelphia, Pennsylvania.

• The company's cable offering, Comcast Cable, is the US' 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 recently acquired DreamWorks Animation for $3.8 billion, and it will become a unit of Comcast's Universal Filmed Entertainment Group. The acquisition is targeted at improving the firm's presence in the family and animation arena. The deal is expected to close by the end of 2016, and adds franchises such as Shrek and Kung Fu Panda to Comcast's portfolio.

• Xfinity Voice has more than 11 million customers, good for a 20% penetration rate. Xfinity High-Speed Internet has ~22 million customers, and it has added at least 1 million customers for 9 consecutive years. The High-Speed Internet segment has increased Internet speeds 15 times in the last 13 years.

• Though cord cutting remains a major concern for all cable providers, Comcast has put up solid results in recent quarters. Its Cable Communications segment's revenue and operating cash flow have grown at a mid-to-high single-digit rate as of late.

Business Quality

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Economic Profit Analysis

In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.

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 11.7%, which is above the estimate of its cost of capital of 9.2%. As such, we assign the firm a ValueCreation rating of GOOD.

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. Its future economic returns warrant an attractive Economic Castle rating.

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Cash Flow Analysis

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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 13.1% 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. At Comcast, cash flow from operations increased about 33% from levels registered two years ago, while capital expenditures expanded about 29% over the same time period.

Valuation Analysis

We think Comcast is worth $61 per share with a fair value range of $49-$73.

The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 3.9% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 6%.

Our model reflects a 5-year projected average operating margin of 23.2%, which is above Comcast's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 1.8% 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.

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Image source: Valuentum

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Image source: Valuentum

Margin of Safety Analysis

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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 $61 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 were 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 above, we show this probable range of fair values for Comcast. We think the firm is attractive below $49 per share (the green line), but quite expensive above $73 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

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We estimate Comcast's fair value at this point in time to be about $61 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Comcast's expected equity value per share over the next three 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 three 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 $79 per share in Year 3 represents our existing fair value per share of $61 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.

This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.