PARA - Warner Bros. Discovery: No Near-Term Outperformance Here

2023-11-09 08:10:00 ET

Summary

• We remain hold-rated on Warner Bros. Discovery.
• While the company saw an improved financial profile in 3Q23, we don’t see enough material near-term catalysts driving top-line outperformance.
• Clearly, WBD results and outlook confirmed that WBD continues to face a weaker advertising spending environment.
• Additionally, we are cautious about the possible strike headwinds impacting its 1H24 results.
• We don’t expect the stock to outperform in the near term.

We're maintaining our bearish sentiment on Warner Bros. Discovery (WBD). Consistent with our expectations back in August, Warner Bros continues to experience lackluster financial performance this quarter, with total revenue growing slightly Y/Y to $9,979M, in line with expectations and loss per share at $0.17 versus $0.6 expected. We think management's efforts to reduce net loss and debt are improving the company's financial profile; this quarter, Warner Bros reported a net loss of $417M, down from $2.31B in a year ago quarter. We're constructive on the company's shift in focus to profitability, especially on the Direct-to-consumer front favoring revenue growth over subscriber growth, but we don't see any near-term catalyst driving financial outperformance into 2024.

Management emphasized limited visibility on the demand environment in 2024, expecting headwinds from the actors' strike to spill into 2024 and a challenging advertising marketplace. We think both negatives have been priced into the stock for the most part; the stock is down 32% since our initiation with a hold in mid-March. The stock is down roughly 25% over the past six months, underperforming the peer group and S&P 500 with the exception of Paramount (PARA). The following graph outlines Warner Bros. stock against the peer group, including Disney (DIS), Netflix (NFLX), Paramount, and the S&P 500.

The stock is down 16% post-earnings today, edging closer to its 52-week low of $8.82. We understand and share investor concerns over the weaker ad spend forecast on the earnings call. CFO Gunnar Wiedenfels noted that 2024 "will have its share of complexity, particularly as it relates to the possibility of continued sluggish ad trends." 3Q23 results confirm the weaker ad environment, with network ad revenue declining 13% Y/Y, matching the drop in the quarter prior. Network revenue came in at $4,868M, down from 2Q23 at $5,780M; the company gets the bulk of revenue from its Network segment, followed by its Studios revenue and then DTC. We see a longer recovery path for Warner Bros aligned with the broader anticipation of the recovery of the TV ad market. We're seeing ad spend for Meta Platforms ( META ) and Amazon ( AMZN ), among other mega-tech companies, rebound this quarter, which is a positive sign, but we have yet to see a rebound in media and entertainment ad spend.

Additionally, we think macro weakness will continue to weigh on DTC subscriber growth. DTC subscribers contracted QoQ to 95.1M subscribers with -0.7M net adds versus 95.8M last quarter. We think there will be a longer growth path to balance accelerating subscriber growth and revenue in the streaming business. We're seeing the peer group who are better positioned to grow subscribers due to content variety and customer base, including Disney and Netflix, still struggle to boost streaming profitability. We expect continued macro weakness and headwinds from the actors' strike to weigh on revenue growth through early 2024.

We think management's reduction of debt will make it better positioned once macro weakness eases and ad spending picks up; this quarter, the company repaid $2.4B of debt with a net debt of $43B at the end of the quarter. The following image outlines the company's update on debt this quarter.

Valuation

The stock is trading below the peer group at 1.7x EV/C2024 Sales versus the peer group average at 3.1x. On a P/E basis, the stock is trading at 58.7x C2024 EPS $0.20 compared to the peer group average of 35.7x. While we see an improving debt profile for the company, we still don't see a reacceleration in growth in the near term. We recommend investors stay on the sidelines. We don't see substantial underperformance after the stock price drop over the past six months, but we don't see the stock working in the near term.

The following table outlines WBD's valuation against the peer group average.

Word on Wall Street

Wall Street is bullish on the stock. Of the 27 analysts covering the stock, 17 are buy-rated, 10 are hold-rated, and the remaining are sell-rated. The stock is currently trading at $12. The median and mean sell-side price targets are $18, with a potential of 55-57%. The following charts outline WBD's sell-side ratings and price-targets.

What to do with the stock

We remain hold-rated on Warner Bros; the stock and outlook have priced in the negatives, but we're holding back on upgrading to a buy as we see no near-term catalyst offsetting the spilling-over headwinds from weak ad spending to strike impacts. We expect the management will continue to execute well on its roadmap to reduce debt and improve profitability, but we think investor money can be better positioned for the near term elsewhere.

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