WBD - Warner Bros. Discovery: Buy The Unjustified Sell-Off

2023-11-17 16:00:00 ET

Summary

• WBD has been temporarily oversold, thanks to Mr. Market's overreaction to its D2C churn, as the ongoing strikes reduced its content launches, worsened by the subscription price hikes.
• Investors should focus on its improving D2C monetization, as ARPUs increase and the segment achieves positive EBITDAs, way ahead of DIS and PARA.
• While it is uncertain if this trend may be sustained, as content spending ramps up after the conclusion of the strikes, we believe that WBD's prospects already look brighter ahead.
• Most importantly, the elevated interest rate environment will not last forever, with things only bound to improve from these extreme conditions.
• We believe that this pullback provides opportunistic investors with the chance to load up, with us still maintaining our long-term price target of $34.94.

We previously covered Warner Bros. Discovery ( WBD ) in August 2023, discussing the potential improvement in its top and bottom lines, thanks to the massive success enjoyed by the Barbie movie.

Combined with its breakeven trend for the D2C segment, returning advertising dollars, and inherent undervaluation, we had rated the stock as a Buy then.

In this article, we will be discussing WBD's oversold status, with Mr. Market over reacting to the D2C churn, as the ongoing strikes reduced its content launches, worsened by the subscription price hikes at a time of tightened discretionary spending.

However, we believe that the pullback provides opportunistic investors with the chance to load up, with us still maintaining our long-term price target of $34.94, based on the calculation in our previous article.

We shall discuss further.

The WBD Investment Thesis Remains Robust For The Brave

For now, WBD has reported a mixed FQ3'23 results , with revenues of $9.97B (-3.6% QoQ/ +1.6% YoY) and GAAP EPS of -$0.17 (compared to -$0.51 in FQ2'23 and -$0.95 in FQ3'22).

Perhaps Mr. Market is expecting a lot more, attributed to the smashing success of the Barbie movie, which reportedly brought in $1.44B in box office at the time of writing.

With Studio revenues of $3.22B ( +24.8% QoQ / +4.5% YoY), the adj EBITDA generation of $727M (+137.5% QoQ/ -4.5% YoY) and EBITDA margin of 22.5% (+10.7 points QoQ/ -2.1 YoY) may have been underwhelming indeed.

In addition, the decline in WBD's advertising revenues in the Networks segment proves to be more drastic than expected at $1.7B (-30.3% QoQ from $2.44B/ -12.3% YoY from $1.94B), resulting in impacted segment revenues of $4.86B (-15.4% QoQ/ -6.7% YoY) and adj EBITDA of $2.39B (+10.6% QoQ/ -9.1% YoY).

It is apparent that the minimal improvement in its advertising revenues in the D2C segment to $138M (+14.4% QoQ/ +30.1% YoY) is unable to make up for the irreversible secular decline of cable networks, especially with the intensifying competition in the D2C advertising market.

It is unsurprising that Mr. Market has turned bearish, in our opinion, since the Network segment has been the media company's top and bottom line driver, despite the sustained cord cutting post pandemic.

Then again, thanks to the price hikes, WBD has been able to report a higher global D2C ARPU of $7.82 (+6% YoY ex-FX).

This naturally explains why the segment has finally achieved adj EBITDA profitability of $111M in the latest quarter, further aided by the drastically reduced D2C expenses of $2.32B (-15% QoQ/ -21.3% YoY). This is compared to its adj EBITDA losses of -$3M in FQ2'23 and -$634M in FQ3'22.

The improvement in the media company's D2C adj EBITDA margins of 4.5% (+4.5 points QoQ/ +31.8 YoY) is highly encouraging indeed, compared to its peers. This includes Disney ( DIS ) at -8% ( +1 points QoQ / +23.1 YoY) and Paramount ( PARA ) at -14% ( +11.4 points QoQ / +13.9 YoY), though still lagging behind Netflix ( NFLX ) at 23.4% ( +0.1 points QoQ / +3.1 YoY) in the latest quarter.

For now, WBD's price hikes during a rising inflationary environment comes with an unavoidable QoQ churn in its D2C global subscriber base to 95.1M (-0.7M QoQ/ +3M YoY).

However, investors need not fret, since the same trend has also been observed with DIS in the FQ3'23 quarter, with 46M of US-based subscribers (-0.3M from FQ2'23/ -0.6M from FQ1'23), before recovering in FQ4'23 to 46.5M.

As a result, we believe that this churn may only be temporal, attributed to the reduced new content launches from the ongoing strikes, with things likely to improve in 2024.

However, WBD investors must also temper their intermediate term expectations, since we expect its D2C segment's profitability to be lumpy, as content productions restart and its Free Cash Flow profitability temporarily impacted.

WBD 1Y Stock Price

For now, thanks to Mr. Market's over reaction to its D2C churn, WBD has already returned most of its recent gains, with the stock currently retesting its critical support levels of upper $9s.

WBD's Growing Interest Obligation

Perhaps, part of the pessimism is also attributed to WBD's growing annualized interest expenses of $2.29B (inline QoQ/ +3.4% YoY), attributed to rising weighted average interest rates for its short-term debts on a QoQ and YoY basis, as highlighted above.

This is despite the notable moderation in its long-term debts to $45.08B (-5.2% QoQ/ -10% YoY) by the latest quarter.

This headwind has directly negated WBD's expanding overall adj EBITDA generation to $2.96B (+38.3% QoQ/ +22.3% YoY), resulting with an impacted GAAP EPS of -$0.17, though still improved compared to -$0.51 in FQ2'23 and -$0.95 in FQ3'22.

WBD Valuations

These headwinds have also contributed to the WBD stock's impacted valuations, with its FWD EV/ EBITDA of 6.43x moderated compared to its 1Y mean of 7.16x and sector median of 8.08x.

With the inflation still sticky, it remains to be seen when the Fed may actually pivot, with the elevated interest rate environment likely to persist for a little longer.

As a result, it appears that the WBD stock may further trade sideways at best, if not further retrace to retest its previous December 2022 bottom of $9.14, implying a -7.5% downside from current levels, based on the stock's lower lows and lower highs thus far.

So, Is WBD Stock A Buy , Sell, or Hold?

Based on its mixed prospects, do we still rate the WBD as a Buy?

Yes indeed, since the management has been diligently deleveraging while optimizing its operations and improving the monetization of its offerings, resulting in our conclusion that the stock has been unjustifiably sold off post earnings call.

Most importantly, the elevated interest rate environment will not last forever, with things only bound to improve from these extreme conditions.

However, there is one caveat to this Buy rating.

With WBD's EPS profitability likely to still be impacted for the next few quarters, investors must also temper their near-term expectations, while adding according to their dollar cost averages.

Consensus FY2025 Adj EBITDA Estimates

However, the consensus still estimates FY2025 adj EBITDA of $12.57B and adj EBITDA per share of $5.17, implying the sustained expansion in its bottom line at an excellent CAGR of +17.7%.

With the consensus still largely optimistic about WBD's long-term profitability, we maintain our previous price target of $34.94, though there is a good chance that things may get worse before it gets better.

As a result, the stock is only suitable for those with higher risk tolerance and long-term investing trajectory. Patience may be prudent for now.

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