Dolby Laboratories: Solid Business With An Extreme Valuation
Summary
- Dolby Laboratories offers products used by many key players in the entertainment business.
- The company operates with a rock solid balance sheet.
- A weaker second quarter is expected due to COVID headwinds, timing under customer contracts and also recoveries.
- The stock is extremely overvalued with a potential downside of roughly 25% when looking at historical multiples.
Investment thesis
Dolby Laboratories (NYSE:DLB) offers products used by many key players in the entertainment business. A weaker second quarter is expected due to COVID headwinds, timing under customer contracts and also recoveries. The stock is extremely overvalued with a potential downside of roughly 25% when looking at historical multiples.
Introduction
Dolby showed a strong performance in the last months and despite being a tech company, new all-time highs were reached recently. The Dolby Vision and Dolby Atmos experience is consistently highlighted among the best ways to enjoy movie and TV content. It's time to review the business status and if the high stock price can be justified with fundamentals and historical multiples.
Before analyzing the latest results, I am going to review the business development over the last 15 years and the balance sheet. These two aspects provide an indication of how the management works. Next, the current stock price is evaluated with historical multiples, followed by a quick risk assessment.
Business execution
A good historical performance is no guarantee for the future success, but it shows how capable the management is over the long run. Let's have a look at some key measures of the last 15 years, starting with earnings per share, free cash flow and dividends.
Source: DividendStocks.Cash
EPS showed a strong increase from 2006 to 2011. After that, it went down slightly and sideways for a few years. This also applies to the free cash flow. Dolby paid a generous special dividend of $4 per share in 2013, starting with regular dividends in 2015. FCF easily covers the dividend payments. All in all, the development is fine, but it's not the type of company with a "bottom left to top right" performance history.
Let's move on to revenue and margins.
Source: DividendStocks.Cash
Revenue development looks pretty good, except some flat years between 2010 and 2015. The operating margin peaked in 2010 at 48.3% and has fallen to 26.4% today. The net margin did not fall as much in the same period. However, that's not a spectacular performance. Analysts are expecting a margin increase in the coming years though.
Balance sheet
Dolby's balance sheet is rock solid. The company is able to create high free cash flow in combination with large cash reserves, offering great potential for future dividend increases. Debt doesn't play a role at all. There is some goodwill, but nothing to worry about.
Source: DividendStocks.Cash
The company operates with an excellent balance sheet and the overall business is solid with a few blemishes.
Q1 2021 update
Revenue was $390 million and well above guidance due to Q4 related shipments and a shift of timing within the fiscal year. On a year-over-year comparison, cinema-related revenue streams were down significantly because of COVID. However, this was more than offset with higher revenues from timing under contracts, higher recoveries, and greater adoption of Dolby.
$373 million are generated by licensing and $17 million came from products and services. The licensing revenue breakdown by end market in Q1 2020 and Q1 2021 is shown below.
Source: Data from Dolby quarterly results data sheet
The mobile business stands out and increased by a little over 200% from last year, primarily due to timing of revenue under customer contracts and also helped by higher customer adoption.
The products and services revenue, coming from equipment that’s sold to cinema exhibitors, significantly decreased because of the COVID impact on the cinema industry.
Dolby Vision and Dolby Atmos are increasingly available across a broad range of new devices and services, enabling more Dolby experiences in music and gaming. The CEO highlight many examples of companies that are supporting Dolby technology: Apple (AAPL) for their AirPods Max, HBO Max as the latest major streaming service supporting Dolby Vision and Dolby Atmos experience and Microsoft's (MSFT) Xbox Series X and Series S to support combined Dolby Vision and Dolby Atmos experience for gaming content.
Current valuation
Dolby is at an all-time high, so let's see how the valuation compares to the past. The dynamic fair value calculation from DividendStocks.Cash is used to calculate the fair value based on historical multiples. More details about the method and procedure can be found here.
Source: DividendStocks.Cash
The P/E based on adjusted earnings per share is used to analyze the current valuation of the stock. Based on the time period between 2015 and 2023 (estimated by analysts), the calculated fair value multiple for P/E adj. is 21.1.
The stock price followed / reflected for many years the business fundamentals of the company, but at the end of 2020, the two somehow decoupled. Dolby is extremely overvalued based on its historical multiple, which suggests a fair price in the range of $75. The projected annual yield is minus 2.8%.
Risks
Talking about risks, Dolby's annual report provides an excellent summary of important aspect to consider.
Source: Dolby 2020 Annual Report
In addition, COVID had and still has a big impact on the cinema business. A weaker Q2 is expected due to timing under customer contracts and also recoveries. The recovery in the cinema space that people might have been expecting seems to be pushing out in time.
The stock is extremely overvalued and priced for perfection. Unexpected news can trigger a significant drop of the stock price. Based on the fair value multiple, a downside of roughly 25% is possible.
Conclusion
Dolby has an outstanding balance sheet and a somewhat cyclical business. Many key players in the entertainment, music, gaming, etc. business are using their products. The latest business update was strong, but a weaker Q2 is expected due to COVID headwinds, timing under customer contracts and also recoveries. The stock is extremely overvalued with a potential downside of roughly 25% when looking at historical multiples. Overall, I like the company, but their business is not bulletproof considering the COVID impact and pressure from competitors. Due to the extremely high valuation, I have a bearish stance on the stock at the moment.
This article was written by
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