Summary
- After Gray Television was disappointed last quarter, GTN stated that they would be more conservative in guidance moving forward - setting the stage for possible earnings surprises.
- Auto ad spend should be increasing with both dealers and manufacturers returning to the market.
- Look for continued deleveraging of the balance sheet, with net leverage around 5.4x at year end.
Gray Television ( GTN ) will release their Q4 and FY results on February 24, 2023 followed by a conference call at 11:00 AM EST. This will be a key quarter as the company looks to bounce back from the surprise miss from last quarter and reassure investors that the company is on track to deliver on the various initiatives that they have undertaken. Gray has a large debt load, with roughly 40% of it being floating rate, so investors want to see the company generate large amounts of free cash flow in order to deleverage the balance sheet.
Here are some of the items we are keeping an eye on when the company releases quarterly results next week:
The Return of Auto
Last quarter management highlighted that the auto category turned positive relative to 2021's Q3, which was the first positive year-over-year quarterly result in years. Another positive regarding the auto category was that core revenue quarter-over-quarter was also positive, so the hope is that the auto dealerships and auto manufacturers are back buying ads after not having to spend any money over the last few years to sell vehicles.
We have noticed that auto spend appears to be up in various markets we travel to just based on the number of commercials we are seeing. It also appears that auto ad spend is showing up on television, whereas both radio and print seem to be lagging. So while this is trending in the right direction, we think it is important to pay attention to this topic as the ramp in spending may slow as both dealers and manufacturers allocate their ad spend through different mediums in the future. While Gray may continue to see the category increase, in any one quarter we might see slower growth as ad dollars are allocated to local radio, etc.
Debt/Deleveraging
While some are worried about Gray's large debt load, we have less concern because of this management team's historical ability to manage the business under large debt loads. Gray has been one of the great stories during this consolidation period in local television and has always carried a large debt load due to their various acquisitions. The key has been that the company has strong and relatively stable cash flows and runs a very efficient business. None of that has changed over the years, but one point of concern is that interest rates have spiked over the last 10 months or so and the company has about 40% of their debt as floating rate debt. With the company not having any hedges in place to manage their exposure to rising rates, many are hoping that the company will aggressively plough free cash flow into debt reduction. Through the first three quarters of the year, Gray has repaid $161 million of its long-term debt and repurchased $50 million of shares, so the cash flow is available for repayments.
The good news for those paying attention to the debt situation is that through 2025, Gray only has $494 million in principal payments - all of which are on the 2021 Senior Credit Facility. The company does not have any large maturities, or principal payments, that could cause problems until 2026, when there is a $1.2 billion+ payment on the 2021 Senior Credit Facility and $700 million due on the company's maturing 2026 5.875% Notes - so $1.905 billion total. The following table is from the company's Q3 SEC Filing (the 10-Q):
On last quarter's conference call Jim Ryan, Gray's CFO, stated in the Q&A session that the company was focused on reducing debt. He also stated that the leverage ratio would be approximately 5.4x to end the year which was a bit above prior guidance, but that the company would be focusing on reducing debt through 2023 and 2024. In the 10-Q there was also a subsequent note explaining that the company made a voluntary pre-payment of $100 million on November 1, 2022.
The company's floating rate debt is currently LIBOR-based, however investors should expect to see SOFR come into play. With that, there could be a change in the spread - something that has been playing out throughout debt markets. There is a recommendation for a default spread adjustment, but some investors, particularly CLO investors, have pushed back and some lenders have been hesitant to make the switch due to possibly receiving lower interest payments. That is definitely a fringe topic, but a transition that should be coming.
Cord Cutting/Retransmission Fees
One of the key issues facing the broadcasters right now is that the networks have negotiated national contracts with the over the top, or OTT and sometimes referred to as vMVPDs, providers which are at rates much lower than what the broadcasters have negotiated with the MVPDs - or Multichannel Video Programming Distributors, think of providers such as DirecTV, Comcast ( CMCSA ) and Charter Communications ( CHTR ). So while it used to be easy to figure out the performance based off of subscribers, now the mix of those subscribers is quite important. One can have the same number of subs but have experienced a migration of those subs from traditional MVPDs to the OTT/vMVPDs which results in lower revenues.
Assembly Atlanta Updates
Gray's Swirl Films division should start productions at the Assembly Atlanta studios that Gray has been developing. Since we are in the middle of Q1, those productions may have already started, or it could be later in March - but either way management should be providing an update on this item as well as more color on the other facilities they are building; namely Comcast's NBCUniversal division's studios and facilities which were on track to be completed on June 1, 2023. The number to pay attention to here is management's guidance that the 2022 FY full year spend on construction costs will be $201 million.
Be Wary Of "Big Beats"
Here is a quote from Kevin Latek, Gray's Chief Legal and Development Officer:
We also are trying to be more conservative on our guide . I'd say we -- we're more than disappointed in missing political. So we're trying to be as conservative as we can in all of our guides going forward ."
The company was embarrassed by the miss due to the political ad spend coming in soft in Q3, and now we have the pendulum swinging in the direction of being cautious on guidance. So investors should be hesitant about any beats that look big and verify that it is actually dramatic outperformance rather than what appears to be a strong beat because management just lowered the bar. The 'smart money' won't be fooled by this, and neither should you!
Final Thoughts
Last quarter was a disappointment for investors with political ad dollars not arriving. Gray's portfolio of stations currently sits in a footprint that should generate outsized revenues in election years due to the number of battle ground states they are in, as well as the local races that take place within their territories. While revenues and FCF for the year will take a hit, the Q4 and full-year results should show that the company is fully capable of generating strong returns for investors. While there are some headwinds that Gray faces, the company has a clear path forward for deleveraging the balance sheet and has created some attractive new avenues for growth - such as the Assembly Atlanta project.
We think Gray is a 'Buy' under $15/share and think that the shares could rise to $20/share or more into 2024 as the company deleverages the balance sheet and investors start anticipating what could be a record year in 2024 for political ad spend.
For further details see:
Gray Television: Earnings Coming In Strong?