DirecTV: Trend To Continue Following Buffett Purchase

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DIRECTV (DTV) is an attractive investment for one of the most successful and famous investors of all time, Warren Buffett. The last 10 years financial statements of DIRECTV were analyzed with the main focus on the last 5 years to determine if "it is good enough for Buffet, then it is good enough for me".

DIRECTV 2007 2008 2009 2010 2011
Revenue Per Share $14.89 $18.75 $22.54 $28.91 $38.59
Operating Margin (%) 48.3 49.5 49.3 49.8 48.7
Net Profit Margin (%) 8.4 7.7 4.7 9.1 9.6
Earnings Per Share $1.25 $1.45 $1.05 $2.64 $3.70
Asset Turnover (%) 115 119 118 135 148
Long Term Debt (millions) 5,316 7,998 9,248 13,429 16,522
Per Share Long Term Debt $4.59 $7.62 $9.66 $16.10 $23.40
Interest Expense (millions) 235 360 423 557 763
Share on Issue (millions) 1,158 1,050 957 834 706

One of the first items to stand out when analyzing the financial statements of DIRECTV is the amount of shares that have been repurchased by the company. In December 2003 the company reported there were 1,482 million shares on issue, by December 2011 the number had been reduced to 706 million. When a company reduces the shares on issue by over 50%, this obviously effects all per share calculations by over doubling the result without any change in the principle figure.

In DIRECTV's case there has also been a large amount of earnings growth in combination with the share buybacks that has delivered spectacular earnings per share growth. For FY2007, the earnings per share was $1.25, by FY2011 the earnings per share had grown to $3.70. The growth in earnings has been predicted to continue with the CEO Michael White stating (29th March 2012) "We've had a terrific couple of years with our Latin America business's performance, and I also want to hope you'll get the understanding that the best is yet to come." Full transcript can be found here.

The earnings growth that has been delivered has been a result of a few factors including the slightly increased margins. While the gross margin has been mostly steady over the comparison period. The operating margin and the net profit margin declined during the GFC, though for the last two years has expanded to a level above that of FY2007. The fact that the margins contracted during the GFC means that an investor needs to be aware that if the economy enters into a "double dip recession" then DIRECTV is unlikely to be the best investment option through those economic times.

Another factor effecting the earnings per share growth is the growth in revenue. On a per share basis revenue has grown from $14.89 in 2007 to $38.59 in 2011.

Asset turnover ratio is calculated by dividing revenue by total assets, the asset turnover ratio helps to identify the trend of how much revenue a business can generate from their assets. For DIRECTV, the assets turnover ratio was basically steady for 2007 to 2009, though for the next two years the ratio experienced rapid growth from 118% in 2009 to 148% in 2011. Meaning that DIRECTV is extracting more revenue from their asset base.

What is a concern within DIRECTV financial statements is the growth in the debt level and the interest expense the company must pay to service the debt. Long term debt has grown from $5,316 million in 2007 to $16,522 million at the end on 2011. On a per share basis the long term debt has grown from $4.59 in 2007 to $23.40 in 2011. Of course when a company expands their interest bearing debt, the interest expense account will increase. Interest expense in 2007 was $235 million, by 2011 the expense was $763 million. While earnings have been growing as well as the debt, it is important to evaluate how much breathing room the company has to service their debt. Earnings before interest tax depreciation and amortization (EBITDA) is compared to the interest expense to evaluate the breathing room for the company. In 2007 EBITDA divided by interest expense equaled 17.75, by 2011 the result had shrunk to 9.15. The increase in debt and interest expense, plus the decrease in the interest coverage ratio means that the company can not continue to expand their debt at the same rate as the last five years. In addition, in the future when interest rates start to rise DIRECTV will have to reconsider the amount of debt they are willing to hold on their balance sheet.

In summary, Buffett is comfortable investing in DIRECTV and I am as well because of the following reasons: The performance of the company over the last five years, plus that the company is expected to continue the growth in the near future, and that the shares can be purchased at a reasonable price at the current levels. Though in my opinion the debt level, interest expense and interest coverage ratio will need to be monitored. In addition, DIRECTV does not appear to be a recession-proof company because of the financial results released during the GFC.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DTV over the next 72 hours.

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