2023-05-18 18:18:44 ET
Summary
- The company continues to trade at undemanding valuations, generating solid levels of cash and materially reducing share count and debt load.
- The main risk to the thesis continues to be the evolution of the cable industry and my assumptions attempt to incorporate that fact.
- After updating to the downside my already conservative assumptions, I continue to rate the company a buy as the expected returns are attractive.
This article is a follow up to my original take on Nexstar (NXST) after two quarters to see if anything significant has changed around the main drivers for the company. I would recommend quickly going through my previous article to have a better handle on the company and the original assumption that I will be reviewing.
I will try to be as thorough and precise as I can delving into the dynamic of Revenues, Margins, The CW Network integration, and the health of the balance to sheet to assess any potential change to my original valuation exercise and overall outlook, always maintaining a conservative basis that provides a sufficient margin of safety.
Revenues
The main driver here are distribution revenues, and those have come slightly below my estimation of 3% growth for the last 2 quarters but markedly below the management estimation of low teens growth. If you simply look at the headline figures reported by the company you get flat a figure for 4Q22 and a 9% growth for 1Q23, but those figures are clouded by the acquisition of The CW Network, and you need to correct for those to get to a fair assessment of the organic dynamics of this segment.
When you do that, you see a 2.8% reduction for 4Q22 and a 6.8% growth for 1Q23, getting to a 1.9% growth for the whole semester. It’s true that during the 4 th quarter the segment was affected by a temporary removal of Nexstar stations as a hard-fought negotiation with one of their cable distributors concluded , but at the same time you cannot forget that the cable industry is in secular decline and this segment cannot escape that reality indefinitely.
To hammer this point, the next chart shows the dynamic of client count and revenue for a significant sample of the industry.
Quarterly Results for CMCSA, DISH and CHTR
In my original take I assumed a 3% revenue growth for this segment up to the 2 nd quarter of 2023 on the back of previously signed distribution agreements and after that, the growth was derived form a 2% annual revenue decline of the cable industry and a closing of half the gap that existed between the viewership share (around 40%) and the distribution payments received (around 30%) by Nexstar stations in a 10-year window. That exercise resulted in a growth rate of -0.4% on 3Q23 that lineally declines to -0.6% in 4Q32.
Looking at the recent dynamic of the cable industry and understanding that a recession is more likely than not in the next 12 months I think is appropriate to be more conservative on the outlook for the cable industry and I will increase the annual decline in revenues to 4% in perpetuity getting to an annual decline rate in revenues that averages 1.6% for this segment starting in the 3 rd quarter of 2023.
After that, we need to check the dynamics for the second most significant segment, Core advertising. My original estimation of an 8% reduction for the last semester was very much in line with the reported figures that showed an 8.6% reduction after adjusting for the inorganic revenues coming from The CW Network acquisition.
My original outlook pointed to one final 8% decline for 2Q23 and then four quarters of recovery at a rate of 6% and after that zero growth. Considering the macro-outlook, I will delay the recovery by two quarters and assume flat figures for the 3 rd and 4 th quarters of 2023 as the comps become easier and the 4 quarters of recovery start in the 1 st quarter of 2024.
Regarding the third most significant segment, Political Advertising my estimation for the 4 th quarter was significantly off as I expected a 2% growth vs 4Q2020 and it experienced a reduction of almost 11%. This was due to a misinterpretation on my behalf of the comments by the management that pointed to the fact that they had reached the revenue levels of the last presidential cycle, but those comment referred to the overall year figures and not to the specific quarter. Despite that, my long-term estimations of 3.5% annualized growth vs the same comparable political cycle (congressional or presidential) continues to be a conservative figure given the excellent track record of the company in this segment. The fact that they managed to equal the revenue of the last presidential cycle in a congressional year is clear evidence of that top notch performance.
Finally, regarding my organic growth estimations for the last two segments that respectively represent 7% and 1% of total revenue, both proved to be higher than the actual figures for the last semester. Digital Revenues decreased by 4.4% vs an estimation of 3% growth and Trade & Other decreased by 14% vs an estimation of 0% growth. Those differences seem large but the impact on the overall results and valuation of the company are relatively immaterial as both segments represent only 8% of total revenues. I would maintain both estimations of long-term growth but to be extra conservative I will assume flat growth for the next 4 quarters for Digital Revenue.
With all those adjustments to my estimations, the of average long-term organic growth decreases by 1% changing from an average of +0.7% to -0.3% for the next 10 years.
Margins and The CW Network
In terms of margins, my estimations were spot on. I was estimating a 45% and 38% organic EBITDA Margin for the 4Q22 and 1Q23 respectively and a $100 and $70 million impact at the EBITDA level because of the acquisition of The CW Network. Including those charges, the EBITDA margin for the last semester came at 35.6%, the exact same level of my estimations.
Regarding The CW Network there is really not much to say as the company is still running the playbook of the previous owners and only starting in the 4 th quarter of this year Nexstar decisions will start significantly influencing the results of the acquired business. What is good to see is that the guidance that the company provided has so far proved to be very much in line with the actual results. Considering that, I will maintain my original estimations, reaching breakeven by the 4 th quarter of 2025 and staying at that level in perpetuity. So, The CW Network has zero positive impact in my outlook for the company . Again, I would agree that this estimation is overly conservative, but as I said in my previous article “I don’t want the investment case to be based on a cash source that does not exist today ”.
Updated Free Cash Flow to the Firm
I won’t explain all over again the details of the exercise as the logic is the same using the updated figures that I previously detailed. But using the closing price of $160 on May 16 th the rate at which the present value goes to zero is 11.45% (8.73 implied FCF exit multiple) an attractive rate of annual return under conservative assumptions, and significantly above the updated WACC estimation for the company.
Balance Sheet and Interest Rate Risk
The balance sheet seems to be healthy with levels of debt that seem more than manageable.
Debt structure continues to stand at roughly 60% floating rate and 40% fixed rate maturing between 2027 and 2028. The increase in interest expense continues at the pace that I expected, the only difference is that now the consensus for the fed is that the peak for rates is 5% to 5.25% instead of 4.75% to 5% at the time of my previous article. With that, that the overall cost of debt for the company should reach 6% in the next two quarters implying higher interest expenses of $16.2 million versus the last 12-month period, as higher rates are partially compensated by lower net financial debt.
Financial Results and St Louis Fed Data
When looking at FCF (adjusted by changes in working capital) to the equity holders we can see that ex-The CW Network, FCF stands at $1,340 million for the LTM, so looking to the next 12 months by deducting the continuing impact of The CW Network ($210 million) and the extra Interest expense, we should be seeing a FCF figure of roughly $1,110 million giving an attractive FCF Yield of 18.5%.
Conclusion
Since my original article the revenue picture has marginally worsened and tracking the evolution of the cable industry seems very important going forward as is probably the most significant risk for the company. But at the same time, since the 3 rd quarter, the company sustainably increased the dividend by 50% , has reduced both the share count and net financial debt by roughly 5% and continues to generate cash at a very healthy pace.
As I said in my last article, even under the conservative assumptions that I am using I get to an attractive 11.45% annual rate of return, and positive surprises are likely to come from either their Political Advertising franchise, the evolution of The CW Network and the potential for new business coming from the new broadcasting standard ATSC 3.0.
And just to finalize, I would repeat that I am not married to this view, and I welcome any constructive criticism and new information that may help me improve my understanding of the company.
Thanks for reading and good luck with your investments!
For further details see:
Updated Conservative Outlook For Nexstar: 11.5% Expected Annual Returns