Summary
- Universal Music Group significantly outgrew its peers in FY22 and proved once again that it's the unquestionable leader of the music industry.
- The company's revenue grew by 13.6%, Adj. EBITDA grew by 11.7%, and Free Cash Flow grew by 70.2%, all in terms of constant currency.
- The music industry demonstrated resiliency despite macro pressures, and the company expects an additional 100M subscribers for music services in the near future.
- I reaffirm my Strong Buy rating and raise my price target to €28.4 per share, or $30.2 per ADR, which represents a 30.6% upside.
I recently wrote an article about Universal Music Group (UMGNF) and rated the stock a Strong Buy ahead of its FY22 earnings. If you haven't read the previous article, I strongly advise you to go over it, as I explain in detail the company's business model and my investment thesis.
UMG just released its FY22 results , which were in line with my expectations. The company significantly outperformed its peers, and there's no sign of slowing down in the foreseeable future. I reaffirm my Strong Buy rating and raise my price target to €28.4 per share, or $30.2 per ADR, which represents a 30.6% upside on the share's price at the time of writing.
FY22 Highlights
Universal Music Group reported revenues of €10.34B, a 21.6% increase from the prior year. Sales came above analyst expectations of €10.27B and slightly below my expectations of €10.50B. Adjusted EBITDA was €2.13B, a 19.4% increase from the prior year, slightly above my expectations of €2.11B. Free cash flow grew by 70.2% to €1.08B. The company announced a final dividend proposal of €0.27 per share, an increase of 35.0% from the prior year, which brings the total dividend for 2022 to €0.51, reflecting a 2.28% yield.
As usual, UMG's artists lead every chart and were the most popular on streaming services:
UMG saw growth across all segments. The Recorded Music segment grew revenues and adjusted EBITDA by 16.3% and 17.7%, respectively. The Music Publishing segment grew revenues by 34.7% and adjusted EBITDA by 33.5%. The Merchandising & Other segment grew revenues by 70.2% and adjusted EBITDA by 125%.
Another important metric to look at is content investments. Catalog investments decreased from €388M in 2021 to €359M in 2022, and royalty advancements dropped significantly from €364M in the prior year to €148M. Management explained we cannot expect a normal run rate for those. Content investments rely on opportunities that arise occasionally and are not something the management can forecast. Royalty advancements are sensitive to deal timing and are also impossible to forecast. However, the decrease from the prior year means an extra €247M of free cash flow. This reflects the difference between music and other forms of content like movies or shows. We see companies like Netflix ( NFLX ) and Disney ( DIS ) having to spend huge amounts of cash every year to keep customers engaged. Music is not like that. Most people listen to the same songs over and over again, and a song remains a relevant valuable asset. This allows companies like UMG to invest only in what they find accretive and valuable, without the need to provide endless new content.
Overall, UMG's results were fantastic, demonstrating the resiliency of music consumption even in times of deteriorating macro conditions.
Results Vs. Competitors
As I mentioned in my previous article, the only comparable competitor to UMG is Warner Music Group ( WMG ). Now that we know the results of both companies for the calendar year of 2022, let's compare and see if our view of UMG as the leader of its industry is correct.
As we can see, the results aren't even close. UMG indeed enjoyed some forex tailwinds, but even if we adjust for constant currency, UMG still wins by a wide margin. By the way, WMG is trading at an EV / EBIT multiple of 27.8 on the trailing twelve months, while UMG is trading at a multiple of 25.8. Looking forward, WMG is trading at 24.1 while UMG is trading at 20.7.
Important Notes From The Earnings Call
UMG announced its long-awaited equity plan, which might put some weight on the stock. Unlike most companies on the market, UMG went public without an already established equity plan for employees. Investors were worried the equity plan will be too aggressive in terms of dilution and waited for the company to resolve this matter. Well, now we know there is nothing to be scared about. The group plans to reward employees via share-based compensation (SBC) at an annual run rate of approximately €200M. This will impact EBITDA by approximately €100M per year in the future. However, for 2023, due to IFRS accounting, the company expects a non-recurring transition expense to the amount of €442M. Overall, the net EBITDA impact for 2023 is expected to be €550M. The company expects up to 5.0% dilution over the next 5 years, which I find to be legitimate. Investors should consider the fact that for European companies, buybacks to offset dilution are less common. Management did not mention any possible buybacks and wasn't asked about the possibility of share repurchases in the future. Thus, I expect no buybacks and a full 5.0% dilution over the next five years.
Regarding the macro environment, the only real effect on the company's results other than the positive FX effect is the decrease in advertising budgets. UMG shares ad revenues with streamers like Spotify ( SPOT ). Management said that it sees some slowdown in that revenue stream, but it remains bullish on ad-based revenues and believes this is a short-term issue. In the future, ad revenues are expected to benefit from the shift of ad spend, from traditional channels like TV to new channels like Alphabet's ( GOOG ) (GOOGL) Youtube. As I mentioned in the previous article, music is a cheap form of entertainment that has shown resiliency in many economic downturns in the past. Specifically, regarding ads, the fact that the company grew revenues at this pace while one of its revenue streams is experiencing some issues makes me even more optimistic about the company's future. I do believe this segment will recover when the macro environment improves, and there's nothing related specifically to UMG.
Macroeconomic headwinds resulting in declines in our partners' ad revenue that put some pressure on our results, but we expect this to be relatively short-lived. We believe the ad support in music services are still in the early stages of monetizing consumer engagement and that our outlook here will improve as the ad market returns to growth.
Online social and video sectors continue to experience migration of ad spending from traditional media, and we continue to enhance our partnerships in the ad-funded sector.
--- Sir Lucian Grainge - Chairman and CEO, Q4 Earnings Call
The most important note from the call is that the company expects additional 100M subscribers, reflecting the significant growth that is still ahead:
We look at a number of different opportunities in terms of the evolution of the Subscription business, including the growth trends that we referenced in terms of the scale of growth that we're reporting, what we see in terms of the total addressable market expansion. And we're very encouraged by our consumer research to suggest that there's more than 100 million subscriptions that we could potentially garner in the consideration set in 13 major markets.
--- Sir Lucian Grainge - Chairman and CEO, Q4 Earnings Call
All in all, I believe FY22 reaffirms the thesis that music is a resilient industry, with plenty of growth ahead. While the equity plan is a direct tailwind regarding the company's financial value, it seems necessary in order to align employees' and shareholders' interests, which means it should be beneficial in the long term.
Updated Financial Model
I use a discounted cash flow methodology to evaluate UMG's fair value. After updating FY22 results, I expect UMG to grow revenues at a CAGR of 9.1% between 2022-2028, which is in line with the management's long-term guidance of high single-digit growth. I estimate revenues will grow at this pace due to price increases of streaming services, an increase in total global subscribers, and the improvement of monetization in social media (mainly TikTok). In addition, I believe advertising budgets will recover in the near future. Regarding price increases, management mentioned the price increases from Amazon ( AMZN ) and Apple ( AAPL ), which have both increased their music services prices by 10.0%. Management expects the full effect of those increases to be shown in the company's 2023 results.
Regarding EBITDA, I project margins to increase incrementally up to 23.4% in 2028, Which is slightly below the management's guidance for mid-twenties EBITDA margins. I believe margins will improve due to a better mix between physical and digital consumption, as well as a lower percentage of merchandising revenues. Due to the announced equity plan, I lowered my terminal EBITDA margin by 2 bps. Excluding the equity plan, I actually increased my EBITDA margin projection, because of the clarity management provided regarding next year's EBITDA.
Let me be clear, the cash compensation savings associated with the equity plan are not the driver of the margin expansion contemplated in our midterm guidance. We continue to expect operating leverage to drive margin improvements in our business both in 2023 and over the midterm.
In 2023, our adjusted EBITDA margin will benefit from both the cash compensation savings and also operating leverage. And therefore, we expect margin expansion to be greater than one percentage point for the year when compared to the 20.6% margin in 2022.
--- Boyd Muir - EVP, CFO, and President of Operations, Q4 Earnings Call
To me, this means the company's long-term mid-twenties EBITDA margin guidance does not include the effect of SBC, meaning management actually expects a higher margin if adjusted for the non-cash SBC expense. In addition, the guidance for next year's EBITDA margin, which is projected to be 1 point above 2022, provides more certainty in the company's ability to deliver on its long-term targets.
Taking a WACC of 8.25% (higher than the previous article due to macro changes), I find UMG's fair value to equal €51.4B, which represents a 30.6% upside compared to its market value on the day of writing.
To check the reasonability of my result, I assign today's FCF yield (4.3%) to my 2025 FCF per share projection of €1.19. This results in a fair price per share of €28.1, which represents a 30.9% upside compared to the stock's price at the time of writing. Pretty close to the DCF valuation.
Converting those numbers to the U.S listed ADR ( UMGNF ), I find it to be fairly valued at $30.2.
2023 Projections
As a European company, it's hard to come by relevant analyst expectations, and UMG does not provide any near-term guidance. While it would be nice to have some external analysis to compare to, my model provided close enough projections for the latest results, and I don't see a reason this would change.
For 2023, I expect UMG to grow revenues by 12.4% and reach €11.6B. I expect an EBITDA margin of 20.65%, excluding the impact of the equity plan. When accounting for the projected €550M impact on EBITDA in 2023, I expect EBITDA to be at €1.9B, reflecting a net margin of 16.9%. For Q1-2023 and H1-2023, I expect revenues of €2.5B and €5.3B, respectively, and net EBITDA of €404M and €877M, respectively.
After the Q1-23 results, we will see if my projections were valid, and update the model accordingly.
Conclusion
Once again, UMG proved it's in a different league when it comes to the music industry. The company represents the most successful artists in the world, and it has the best operations in place to profitably monetize them. UMG outgrew its peers by a wide margin, even though it is already the biggest music label in the world. I don't see anything that can slow down the company in the foreseeable future. Thus, I reaffirm my Strong Buy rating, with a price target of €28.4 per share and $30.2 per ADR, which represents a 30.6% upside compared to the stock's price at the time of writing.
For further details see:
Universal Music Group: FY22 Earnings Are Out, Strong Buy Reaffirmed