2023-08-30 08:18:27 ET
Summary
- Warner Music Group is benefiting from continued growth in the global music market and recent price hikes by streaming service providers.
- The company recently hiked its quarterly dividend, which is supported by overall solid fundamentals.
- We expect earnings momentum to push shares higher into 2024.
Warner Music Group Corp. (WMG) is an entertainment leader with a portfolio of global record labels and a publishing catalog representing more than 100,000 artists. The company has found success in its long history by adapting to ever-changing music trends and shifting consumption channels including the rise of streaming services over the past decade.
WMG is a stock we covered last year with a bullish note focusing on the opportunity for the company to enter new digital segments. While shares have been volatile and currently trading slightly lower over the period, the company's latest result works to reaffirm a positive long-term outlook.
A key development here is the move by major streaming providers to hike prices as a growth runway for WGM's core business while removing a layer of uncertainty that had clouded the industry. In our view, stronger earnings momentum going forward should support a sustained rally in the stock.
WMG Q2 Earnings Recap
WMG reported fiscal Q3 EPS of $0.23 , $0.03 ahead of expectations. Total revenue of $1.6 billion, climbed by 9.1% year-over-year or 10% on a constant currency basis.
Adjusted operating income before depreciation and amortization (OIBDA) of $297 million, increased by 18% y/y. This reflected the impact of cost savings efforts including an announced headcount reduction earlier this year. There has also been a shift in the business mix toward some higher-margin categories .
On the recorded music side, the quarter was strong for new releases, including albums from superstars like "Ed Sheeran" with a studio album that reached number one on the charts in eleven countries.
Growth has also benefited from the renewal of streaming contract deals with more favorable terms as mentioned. This includes several high-profile companies like Apple Inc (AAPL), and Amazon.com Inc (AMZN) hiking their baseline prices over the past year for their paid tier of unlimited music services.
Naturally, a portion of those fees flow through WMG's top line, including on the publishing side, and represent a tailwind for the business. Beyond exposure to "traditional" streaming services, the company is also finding momentum with partnerships on platforms like Instagram from Meta Platforms Inc (META) and "TikTok" which feature WMG's music content library available to user-created content.
In terms of guidance, the company is focusing on the adjusted OIBDA margin, with a target for that metric to climb at the "high end of a 50 to 100 basis point" range improvement compared to 2022. For context, that measure climbed by 140 basis points year-to-date to 19% from 17.6% in Q3 2022. Management projected confidence in the outlook during the earnings conference call .
Following the Q3 earnings report, WMG hiked its dividend by 6% to a new quarterly rate of $0.17 per share. This is the third annual increase since 2021 with the stock now yielding 2.1% on a forward basis.
The payout is supported by positive underlying free cash flow. The company ended the quarter with $600 million in cash and equivalents, against $4 billion in total debt. Notably, WMG does not have any significant debt maturities until 2028. Considering the run rate for EBITDA above $1 billion, we view the balance sheet position as stable with some room for improvement in line with earnings through next year.
What's Next For WMG?
The growth drivers for WMG are both the expanding reach of its recorded music and publishing along with the ability to secure higher pricing. Favorably, both these factors are moving in the right direction.
WMG CEO Robert Kyncl has been vocal about the need for digital streaming providers to raise subscription fees , which can be distributed to the collection of singers, songwriters, and composers that the company manages.
Following the moves by Apple Music and Amazon last year, Spotify Technology SA ( SPOT ) announced in July that it was hiking the price of its premium package in the U.S. by $1.00 to $10.99 per month, the first such increase in over a decade since the platform launch back in 2011.
That move should be reflected in higher revenues for WMG over the next year. The understanding is that there is still room for streaming pricing to climb over time, as it has not kept up with global inflation trends.
On the demand side, data from the independent International Federation of the Phonographic Industry (IFPI) group shows the global recorded music market grew by 9% in 2022 to reach $26.2 billion. Within that amount, streaming represented 67% of the total share, a level that has more than doubled in the past 5 years.
The expectation is for that momentum to continue, with several underpenetrated regions like Asia-Pacific, Latin America, and even sub-Saharan Africa leading the way with double-digit expansion.
In our view, the attraction of investing in WMG, compared to a streaming service provider like SPOT, is simply that it's the record labels and publishers who control the content that are best positioned to benefit over the long run.
WMG has the advantage of being platform-agnostic while its worldwide exposure covering various genres adds a layer of diversification. Whether Spotify succeeds or a different service gains market share, WMG is what ultimately keeps the music playing.
According to consensus estimates, the expectation is for WMG to maintain steady top-line growth in the mid to high-single digits over the next few years. In terms of earnings, an EPS forecast of $0.98 this year represents a decline of -22% from 2022. Keep in mind, this metric captures the outsized impact of FX volatility against the company's Euro-denominated debt position earlier this year.
The more important trend to consider is the underlying level of operating income better measured by the OIBDA which is approximately flat year-to-date but up meaningfully in Q3.
A normalization going forward, including capturing firming margins and the impact of higher streaming deal prices leads to an outlook for EPS to climb by 39% next year in fiscal 2024. By this measure, we view WMG trading at a 1-year forward P/E of 24x as attractive with some room for multiples expansion.
Final Thoughts
There's a lot to like about WMG as a category leader with overall solid fundamentals and significant long-term growth opportunities. We believe its position in the industry and profile as a pure play on "upstream music" makes it a unique stock that warrants a valuation premium.
From the stock price chart, we note that WMG is trading at the upper range, a down-running trend in place since late 2021. We believe the next leg is higher and we have a price target on the stock at $40 representing a 30x multiple on the current consensus fiscal 2024 EPS estimate.
The recent moves by streaming players to hike prices as a new catalyst for the stock. The bullish case here is that the company exceeds expectations over the next several quarters, capitalizing on the breadth of its distribution channels.
In terms of risks, there is a connection here to leisure and entertainment within consumer spending. While not our base case, a scenario of deteriorating economic conditions would likely pressure everything from concert ticket demand to album sales and the momentum in streaming services forcing a reassessment of WMG's earnings outlook.
Monitoring points over the next several quarters include the evolution of the operating margin along and cash flow trends as a measure of financial execution.
For further details see:
Warner Music Group: Bullish As Streaming Services Press Play On Price Hikes