DIS - Paramount: Is Recovery A Mission Impossible?

2023-09-26 14:00:00 ET

Summary

• PARA's profitability remains shaky, despite the dividend and headcount cuts, worsened by the sustained cord-cutting post reopening cadence.
• Since the TV Media segment has been consistently subsidizing the D2C cash burn, the company's prospects remain mixed, with the raised subscription fees potentially increasing its churn rate.
• Despite the ongoing SAG-AFTRA/WGA strike and the subsequent reduction of content spend, the media company still fails to report positive Free Cash Flow generation.
• With content spending expected to intensify in FY2024 once the strike is resolved, subsequently impacting PARA's FCF generation, investors may want to brace themselves for more underperformance ahead.

The PARA Investment Thesis Remains Shaky In The Near Term

We previously covered Paramount Global ( PARA ) in June 2023, discussing the management's prudent choice of cutting dividends and headcounts, in order to preserve its deteriorating balance sheet.

Then again, it might also seem that its efforts had been too little and too late, due to the intensifying streaming competition and declining profitability. We had concluded with a Hold rating then, since we were uncertain if the March 2020 bottom might hold in the near term.

For now, the sustained cord-cutting post reopening cadence has naturally diverted much of the advertising dollars to the streaming industry, impacting PARA's TV Media segment.

In FQ2'23, it records TV advertising revenues of $1.94B (-13.7% QoQ/-10.5% YoY) in FQ2'23, naturally moderating the segment's adj OIBDA to $1.19B (-8.4% QoQ/-13.7% YoY).

With the segment's FY2022 adj OIBDA of $5.45B (-7.4% YoY) subsidizing PARA's D2C cash burn of -$1.81B (-83.3% YoY) and Film Entertainment's minimal profitability of $272M (+31.4% YoY) then, these developments are extremely concerning indeed, assuming a further decline in its advertising dollars.

This is especially since its D2C segments remain unprofitable with adj OIBDA of -$424M (+17% QoQ/+4.7% YoY) in FQ2'23, despite the drastic jump in its subscriber base to 60.7M (+0.7M QoQ/+17.4M YoY) and advertising revenues to $441M (+10.8% QoQ/+21.4% YoY).

While PARA has opted to follow the market trend of hiking streaming subscription fees by an average of +20% starting July 27, 2023, we expect to see some churn ahead as well, as previously reported by Disney ( DIS ).

For example, the Mickey Mouse company has recorded a notable -0.6M decline in its domestic subscriber base over the past two quarters, with the management already introducing two price hikes since December 2022.

Therefore, it remains to be seen how PARA's D2C segment may perform ahead, since part of the churn may negate the eventual subscription revenue tailwinds in H2'23, as the interest rates remain elevated and the federal student loan payments restart from October 2023 onwards.

So, Is PARA Stock A Buy , Sell, Or Hold?

PARA Valuations

For now, PARA trades at FWD EV/Sales of 0.81x, FWD EV/EBITDA of 10.68x, and FWD P/E of 27.29x, elevated compared to its 1Y mean of 0.83x/10.10x/19.15x, respectively.

However, we believe that the stock is still trading at a premium, compared to the Media sector median FWD EV/EBITDA of 8.21x and P/E of 14.19x. This is especially due to its minimal annualized adj OIBDA of $2.42B (+10.5% QoQ/-37% YoY) in the latest quarter.

However, we believe that the adj OIBDA may not be an accurate metric to look at, due to its elevated long-term debts of $15.61B (inline QoQ/-1% YoY). By the latest quarter, the company reports growing annualized interest expenses of $960M (+6.1% QoQ/+4.3% YoY), naturally impacting its EPS profitability.

While the PARA management has made some efforts to sell some assets to pay down part of its debts by approximately $2.2B, it remains to be seen when its Free Cash Flow generation may turn positive.

If any, despite the ongoing SAG-AFTRA/WGA strike and the subsequent reduction of content spend, PARA still fails to report positive Free Cash Flow generation at -$210M (+62% QoQ/-259.2% YoY) in the latest quarter. This is on top of the underwhelming consensus FY2023 estimates of -$313M (-125.1% YoY).

This is compared to Netflix's ( NFLX ) and DIS's projected outperformance in FY2023, with FCF of $5B (+210% YoY) and $4.27B (+303.2% YoY), respectively.

PARA has originally guided $4B in D2C content spend in 2023, with less than $6B for 2024. However, with the ongoing strike, the management " anticipates continued delays in production for the duration of the strikes... leading to the free cash flow in the back half of the year to be significantly higher than previously expected."

While we may see improved profitability in H2'23, the inverse may also hold true, in that content spending may intensify in FY2024 once the strike is resolved. Since this may subsequently impact PARA's FCF generation, existing investors may want to brace themselves for more underperformance ahead.

Therefore, based on the sector median P/E valuations and annualized FQ2'23 adj EPS of $0.40 (+11.1% QoQ/-84.3% YoY), the PARA stock's current fair value will come to $5.67.

Consensus Forward Estimates

Perhaps, much of the optimism embedded in PARA's valuations is attributed to the consensus FY2025 adj EPS estimates of $1.65, suggesting a potential upside potential of +85.2% to our long-term price target of $23.41.

PARA 5Y Stock Price

However, it appears that Mr. Market is pessimistic about PARA's forward prospects as well, especially due to the lower highs and lower lows over the past few months.

With the stock currently retesting its March 2020 bottom, it remains to be seen if the previous floor may hold, implying more volatility in the near term.

As a result of the potential capital losses, we do not recommend anyone to add here, resulting in our Hold (Neutral) rating.

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