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Back to Part XII

By Mark Bern, CPA CFA

The cable TV industry still has more growth potential in both the top and bottom lines, but the competition is getting tough. That is why we must be very careful in our selection process to find the best option for the long term. If you are just reading this series of articles for the first time, you may find the original article that I used to begin the series helpful to understand the process I use in selecting companies for my master list.

There are three primary features of the cable industry that I deem as favorable. First, many of the companies in the industry are in good financial health. Second, the trend toward bundling multiple services should continue to improve revenue per subscriber and keep increases in programming costs from adversely affecting the bottom line. Third, share-buyback programs continue to dramatically reduce the number of shares outstanding, thereby helping to fuel increases in EPS. The dividend yields aren't bad either.

Internet video streaming will eventually become a problem for the industry, but I expect that the impact will remain manageable over the next few years as most cable subscribers continue to cling to their regular programming addictions and are proving to be slow in responding to the availability of what the Internet offers. The younger generation is going to adopt the new technology more rapidly than the current subscriber base, but eventually we will need to reassess the industry. Until then, there remains money to be made in cable if investors are selective, in my opinion.

The only company in the industry to make the grade is Comcast (CMCSA). There are other companies that may fare well in the short term, perhaps even better than Comcast, but for the longer-term investor I believe that Comcast offers the more stable and predictable income stream we seek. Comcast is the leader in the U.S. cable TV market with more than 22 million video subscribers in 39 states and the District of Columbia. It has over 18 million Internet subscribers and over 9 million phone service subscribers. The company is diversified beyond just cable, owning a 51% stake in the NBC Universal joint venture. It also owns the Philadelphia Flyers and the Wells Fargo Center.

The stock price is a bit pricey right now by my estimates, but it does offer some good appreciation potential over the long term as I expect total return to average above 12% a year over the next five years. But waiting for a better entry price is probably the best route for patient investors. Let's look at how the company fared against the metrics.

Metric

CMCSA

Industry Average

Grade

Dividend Yield

2.1%

1.2%

Pass

Debt-to-Capital Ratio

45.0%

70.9%

Pass

Payout Ratio

27.0%

15.0%

Fail

Five-Year Average Annual Dividend Increase

21.0%

N/A

Pass

Free Cash Flow

$0.03

N/A

Pass

Net Profit Margin

7.8%

7.3%

Pass

Five-Year Average Annual Growth in EPS

27.5%

59.8%

Fail

Return on Total Capital

6.6%

7.2%

Neutral

Five-Year Average Annual Growth in Revenue

31.6%

25.0%

Pass

S&P Credit Rating

BBB+

N/A

Pass

Comcast receives two fails and one neutral rating against seven passes. The industry average growth in EPS is primarily due to losses posted in the baseline period by about half of the companies in the industry. This made earnings comparisons over the period much easier for the industry as a whole. Comcast has posted an unbroken string of eight consecutive years of increasing EPS. Prior to that, positive EPS was difficult to achieve in the industry due to heavy investments in new technology and the costs of rolling that technology out to the subscriber base. Now the industry is reaping the benefits of those investments.

Time Warner Cable (TWC) lagged the industry in EPS growth at only 10.1% per year, has negative free cash flow (by the method I use) of $5.54 per share, and its debt-to-capital ratio also exceeds the industry average at 76.0%.

Shaw Communications (SJR) would have gotten consideration, but the company's credit rating is too low. I like Shaw's growth prospects and will continue to watch for improvement in the balance sheet. Otherwise, the company also has negative free cash flow of $1.04 per share (again, by my very conservative, worst-case scenario methods).

Of the remaining companies, Cablevision (CVC) was in the group that was losing money as recently as 2006. Dish Network (DISH), DirectTV (DTV), EchoStar (SATS), Knology (KNOL), Liberty Global (LBTYA), and LodgeNet Interactive (LNET) do not pay a dividend and therefore were not reviewed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: The Dividend Investors' Guide: Part XIII - Connecting With The Cable Industry