2023-05-15 17:29:41 ET
Summary
- Charter has some ambitious goals for spectrum enhancement and rural expansion through FY25.
- Steep financial gearing, weak operating leverage, and declining cash generation may place hindrances on fluid execution.
- Valuations are no longer pricey, and the risk-reward looks attractive.
Company Snapshot
Charter Communications, Inc. ( CHTR ), a large-cap stock, is a play on the changing texture of broadband and cable services in the US. The company offers subscription-based internet, video, mobile, and voice services, to not just residential customers but commercial customers (~7% of total CHTR’s group customer relationships) as well. In effect, CHTR’s broad network - which it owns and operates - passes through 56m households and businesses across the country.
Long-term Ambitions Look Compelling, But It Won’t Be Clear Sailing
Over the years, Charter has managed to build a competent two-way telco network, that enables it to render high-capacity internet, video, mobile, and TV services. Yet, it isn’t resting on its laurels and wants to press the pedal with greater fervor. Through FY25, it will look to facilitate even greater spectrum enhancement on its coaxial network, which could result in multi-gigabit speeds (from 2GBPS speed to >5GBPs speed) being delivered at low costs. Basically, the goal is to transition from 1.2 GHz network capacity to 1.8 GHz by the end of FY25. Greater upstream speeds will also call for higher splits, and you'd also have a more pronounced influx of DOCSIS 4.0 tech (Data over Cable Service Interface). Besides all that, CHTR also wants to deepen its rural footprint, particularly in the eastern regions of the country.
All these are rather exciting initiatives, which would position the company very well in a couple of years’ time, but let’s also not play down the enhanced degree of capital intensity that would be required to execute these plans. That’s where things have become a little challenging with Charter.
The trend of free cash flow generation is typically a good measure of gauging financial health, and we can see from the image below that this has been slowing down since the turn of FY22; in fact, it recently dropped below the $5bn mark on a trailing-twelve-month ((TTM)) basis (in Q1, FCF was down by almost 3x YoY)
A solid chunk of the FCF weakness is being driven by higher CAPEX spend. For context, in the recently concluded Q1, CAPEX came in at an exorbitant $2.46bn, a 33% YoY spike, driven primarily by $0.9bn of line extension investments (65% YoY increase). As we progress through FY23, the threshold of CAPEX spend per quarter is likely to ramp up with an FY total CAPEX outlook of $10.5bn-$10.8bn (of this figure, non-line extension CAPEX is likely to oscillate between $6.5bn-$6.8bn).
If it was just higher CAPEX intensity, one could make peace with it, as ultimately one could reap the benefits of this over time, but even operating cash flow generation has slumped in recent years. Charter’s CFO (cash flow from operations) conversion per dollar sale used to be well above the 30% mark, but since Q4-21 it has been sliding.
In effect, the margin by which it covers its CAPEX outlay has hit its lowest point in five years, at just 1.25x. Now with even higher capital intensities going forward, you would think it could drop below 1x, which would then make it very dependent on even more external financing.
The problem with taking on more debt is that Charter’s current leverage level (net debt to adjusted EBITDA) is already at the higher end of management’s long-term target range (4-4.5x) making it even more vulnerable.
Granted, taking on more debt doesn’t necessarily have to be a problem per se, if you can demonstrate ample operating efficiency in covering your interest costs, but the image below shows you how the interest coverage by EBIT has been on a declining trend in recent quarters, even as the total net debt inches closer to the $100bn mark!
Speaking of operating efficiency, we can see that CHTR’s EBITDA growth has been lagging revenue growth for the last three quarters, and as per YCharts estimates, this will linger through this year (with FY23 rev growth expected to come in 50bps lower than EBITDA growth).
Earnings presentation, YCharts
Investors should also note that weak FCF dynamics will also leave even less ammunition for the company to engage in buybacks, something for which this stock has built a reputation. Already we’re seeing evidence of this. Some time back the company was deploying over $4.5bn per quarter to buy back shares, these days it is less than a billion.
Closing Thoughts
If you’re enthused by CHTR’s ambitions and not daunted by the significant level of gearing and weak FCF generation, we’ve got a few more encouraging themes to highlight.
Given a weaker cadence of operating leverage through this year, it’s not entirely surprising to discover that Charter stock is no longer priced exorbitantly. Based on the estimated FY23 EBITDA sell-side figure of $21.98bn , the stock only trades at a forward EV/EBITDA of 6.9x, which translates to a ~11% discount over the stock’s long-term forward multiple .
Then, if we switch our attention to the stock’s weekly price imprints, we can see that from September last year until the end of the year, the stock had been sliding down in the form of a descending channel. The downward slide has since transitioned into a flattening out of the price action since the turn of this year. Potential bottom formation in the stock is supported even further by declining readings on the average true range indicator. Even if you don't believe the stock can kick off a bout of sustained ascending movements, you may consider trading the range of $300-$415 levels that have been in play since mid-September last year. If one were to stage an entry at this juncture, the risk-reward looks quite favorable at 1.9x.
Finally, if one considers how Charter Communications is positioned relative to its peers in the communication services sector, we can see that the stock no longer looks overbought (which was the case in late 2020). Crucially, the relative strength ratio is not far from hitting the 5.5x levels, a point from where the stock had typically witnessed more constructive interest (see 2014 and 2018 previously).
For further details see:
Charter Communications: Fundamentals Are Not In The Best Shape, But Risk-Reward Looks Attractive