2023-12-14 09:34:05 ET
Summary
- Charter Communications shares have lost 2% of their value in the past year, with mixed results and concerning outlooks.
- The company's revenue growth has decelerated due to a decline in video and disappointing broadband gains.
- Charter's mobile unit is seeing strong growth, but it is being offset by weakness in video and essentially flat internet position.
- With leverage near the top end of its target, a downturn in the business will force debt paydown rather than buybacks.
Shares of Charter Communications ( CHTR ) have been essentially dead money over the past year, losing 2% of their value, though there has been significant volatility along the way as the company has reported mixed results and given concerning outlooks. Offsetting this, it continues to aggressively repurchase stock, even with its debt level being high. Given minimal growth prospects, I view shares as expensive and would be a seller.
In the company's third quarter , CHTR earned $8.25; this was up 12% from last year and beat consensus , with much of that due to lower depreciation, a non-cash item. Revenue last quarter was essentially flat at $13.6 billion. As you can see below, the company's revenue growth has decelerated over the past year as video faces a secular decline. Broadband gains have been disappointing, and while mobile growth is very strong, the base is so low that revenue gains are not yet moving the needle.
Last quarter, it added just 63k residential and small-business customers. The one bright spot is that its mobile unit added 594k lines from 396k a year ago. Charter essentially is renting space on the wireless carriers' networks and selling mobile services as an add-on to its customers, and the company is seeing strong growth here. Importantly, this growth is actually accelerating. That is the one clear positive in the company's results. As you can, though, this growth is being offset by essentially a flat internet position and weakness in video.
Now, Charter's residential business accounts for 79% of the business - it is the main driver of results. Simply put, its performance is sluggish. Residential revenue was down 0.3% to $10.74 billion due to a $63 million decline from Disney customer credits. Excluding this, revenue was essentially flat. This was because customers were broadly flat, and revenue per customer was flat from last year, excluding the Disney impact, at $120. Penetration is down to 57% from 58.1% last year - this measures Charter's market share among customers who have access to its network. It is extending its network, reaching more customers, but still only keeping a flat customer count, a costlier proposition.
Moreover, while the customer count is broadly flat, the company is selling less to each customer. 46.5% have just one product from 45.9% last year as its share of non-video customers rose to 54.2% from 51.1%. What we are seeing is that broadband is much stickier than video-this is no surprise. If a customer decides to "cut the cord" and just consume streaming services, they still need the internet.
This is why shares plunged 8% earlier this month when the company said that net-adds in high-speed internet have been "soft," which could lead to broadband subscriber losses in the quarter. If anything, life is becoming more dependent on internet access, so I would expect broadband trends to be resilient, especially as competition from 5G wireless providers is still fairly nascent. Now should be a time when the cable companies can grow their broadband base. We are simply not seeing that, which is why revenue growth has fallen to essentially zero.
Internet subscribers are up a modest 1% from last year at 30.6 million while video subscribers are down 6% to 14.4 million. This mix shift is also a significant revenue headwind. Video drives 68% of internet revenue ($4 billion vs $5.8 billion) despite having less than half the customers. Internet revenues fell by $375 million or 9%. This is actually 3% worse than subscribers, mainly due to Disney. Still, this points to minimal pricing gains. Internet revenue rose $205 million or 3.7%, offsetting about half of the lost video revenue.
As I noted earlier, the company has been aggressively adding mobile subscribers. Mobile users are up an impressive 54% to 7.2 million However, revenue rose just 34% to $145 million. Charter has been quite promotional, offering one-line free with unlimited data, which is why revenue is growing more slowly. It should also be noted that 34% of revenue growth here is only about 40% of the revenue lost in video. While mobile is helping, the financial impact of the fast growth here is still pretty modest.
While Charter's residential unit has been slow, its commercial unit has been a bit stronger as revenue rose by 0.8% aided by 3.7% strength in large enterprises. One other headwind is that advertising was down 20%, as its local stations saw less political spending in a non-election year. That should rebound next year. Other revenue rose by 29% as a higher mobile user base is leading to increased device sales.
Given the lack of revenue growth, adjusted EBITDA rose by under 1% to $5.45 billion. Faced with little top-line movement, the company has focused on costs. Operating costs to provide services rose by 3.7% due to higher labor costs, but the company reduced headcount in sales and marketing, taking expenses down 1.4% from last year. While it has focused on reducing operating expenses, cap-ex last quarter ran at $3 billion from $2.4 billion last year as it spends more to upgrade its network.
As such, its free cash flow declined from $1.5 to $1.1 billion. Through nine months, Charter has generated $3 billion in free cash flow, adjusted for working capital. Charter is returning this cash to investors via a repurchase program, and it bought back $854 million of stock last quarter. Its share count is down 5% from last year.
While the company is returning cash to shareholders, it has a fairly stretched balance sheet. Its debt/EBITDA leverage is at 4.45, at the very high end of its 4-4.5x target. Charter carries $97.8 billion of debt, which is roughly flat this year. For comparison, Comcast carries just $88 billion of net debt despite having about 90% more EBITDA, which is why its net leverage is just 2.3x. In a higher interest rate world, having less debt is a positive.
Even with a fairly flat debt load, Charter's interest expense rose from $1.16 billion last year to $1.31 billion this year as it has refinanced debt at higher rates. Next year, Charter just has $2.4 billion in maturities, but if rates stay higher for longer, its $7 billion in 2025 maturities could be rolled over at higher rates, further pressuring cash flow. Interest expense is likely to be a gradual, but ongoing headwind for the company. And with leverage already at the high end, if we do see a deterioration in EBITDA, management could be forced to slow share repurchases to pay down debt.
Some companies can grow into large debt loads, but it is hard to see how CHTR can generate much growth. Video is likely to be an ongoing headwind, more than offsetting mobile gains while broadband has decelerated, creating a flattish business. Businesses like this can still generate substantial cash flow; to be clear - I expect CHTR to generate about $4 billion in annual free cash flow. But, the growth in free cash flow is likely to be very modest.
And, with growth lacking, I prefer to see balance sheet flexibility. That can enable companies to continue buybacks even during downturns. Instead, with a constrained balance sheet, buybacks may have to slow. Shares do not seem to reflect this financial position because they are trading about 7.6x EV/EBITDA. For comparison, Comcast trades at 7.2x EV/EBITDA . However, Comcast also has non-cable businesses, like Peacock, NBCUniversal, theme parks, and its stake in Hulu. In my sum-of-the-parts analysis , I estimated Comcast's legacy cable and internet business is being valued at about 6x, which is the more comparable metric to CHTR, given it doesn't have a large media division. CHTR's buyback has helped to prop up shares, and its reliance on debt financing worked well when rates were lower.
However, top-line growth is hard to come by, free cash flow is under pressure, and rates are much higher. I struggle to justify CHTR's premium valuation, and given the lack of growth, its 6.7% free cash flow yield is expensive. Until we see signs of video stabilization or broadband acceleration, investors should avoid CHTR, and I would only be a buyer at an 8% free cash flow yield or $300-310/share. That represents about a 16% downside. At current levels, Charter is a sell, and cable investors should rotate into Comcast, which has a superior balance sheet and more diversified business. At its current valuation, Charter stock is reflecting an acceleration in the business that is not readily apparent.
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Charter Communications: Elevated Debt And Slow Growth Make Shares Unattractive