EUR 850.00 For Business Accounts Only

Morningstar | Comcast Ends 2018 on a Strong Note; Increasing FVE to $45. See Updated Analyst Note from 23 Jan 2019

Comcast’s cable and media businesses performed admirably thought 2018, despite distractions from the Sky acquisition and Fox bid, in our view. Cable customer growth continued to accelerate during the fourth quarter, as the firm emphasizes its strength in the Internet access market. Even the much-maligned television business fared reasonably well, with very modest customer losses in the quarter. At NBCU, contractual price increases and a solid ad market offset weaker ratings across broadcast and cable television networks, boosting current results but leaving open questions regarding the long-term strategy for these businesses. In that vein, Comcast management spent time discussing its planned direct-to-consumer television offering, which we believe will create additional options to monetize NBCU content.

With a clean look at Comcast’s balance sheet and operations following the Sky deal and slightly more optimistic estimates for the core cable business, we’re increasing our fair value estimate modestly to $45 from $42. We continue to believe Comcast warrants a wide moat rating. Even with the jump in price following the fourth-quarter earnings release, we believe Comcast's shares are undervalued.

Cable segment revenue increased 5.2% year over year during the quarter, the fastest pace in more than a year thanks primarily to strong political advertising (Comcast generally has rights to a sliver of commercial time on the television networks it distributes). Excluding political ad revenue, however, growth was still solid. Comcast added 1.4 million net new Internet access customers during 2018, growing its base 5.2% during the year, while revenue per customer increased 4.3%. The television business posted solid improvement during the second half of the year, which we suspect reflects reduced promotional activity around DirecTV Now. Television net losses during the fourth quarter totaled only 29,000, leaving the television customer base 1.7% smaller than a year ago.

Solid cost controls and moderating programming cost growth fueled another bump in cable profitability, as the segment EBITDA margin increased slightly year over year to 40.2% For 2018, the segment margin hit 40.7%, up a percentage point versus the prior year and the best result since 2014. Management expects another 0.5 percentage point margin increase in 2019, which we suspect could be on the conservative side given the continued shift in revenue toward higher-margin Internet access and commercial services. However, Comcast will move its wireless effort into the cable segment for reporting purposes in 2019; that business lost $743 million during 2018, a figure that should shrink somewhat as the wireless customer base scales. Wireless customer growth was disappointing during the fourth quarter, with 227,000 net additions down slightly sequentially.

NBCU revenue increased 7.1% year over year during the quarter, with each business segment contributing. The cable and broadcast networks again produced strong subscription (affiliate and retransmission fees) and advertising growth, with contractual rate increases offsetting continued gradual customer losses. Advertising revenue growth was weak, however (0.2% in cable and 2.1% in broadcast), despite the political environment, reflecting ratings weakness. NBCU plans to launch its direct-to-consumer television offering in 2020, with free access to existing pay-television customers in the U.S. and Sky customers internationally. This offering should expand customers’ access to NBCU content and allow the firm to better target advertising, improving the rate of ad revenue growth.

More important, in our view, the new DTC offering should provide NBCU with optionality to deal with changing television habits. Management commented that it views the DTC offering as another bidder for NBCU content, adding to existing customers like Netflix. Management also stated that it doesn’t believe NBCU content is not monetizing online as well as it should, which we take to mean firms like Netflix aren’t currently paying amounts that reflect the value of NBCU content to those platforms. In addition, we suspect Comcast will look to sell Hulu to Disney after Disney consolidates control of the online platform with the Fox acquisition. Thus, by creating its own platform, we believe NBCU hopes to gain negotiating leverage against these increasingly dominant online players. Further, by offering the DTC service free to existing pay-television customers, NBCU should be able to grow customer familiarity with its platform quickly, making it a legitimate home for valuable content. In short, we believe NBCU is rightly keeping itself open to placing content on whichever platform (owned or not) that can best monetize each piece of content it owns while working to maintain negotiating leverage. This strategy isn’t without risk, though, and we still expect the television segments will struggle to grow over the longer term.

On a consolidated basis, Comcast generated $12.0 billion of free cash flow during 2018, up 23% year over year thanks to tax reform and growth in the business. Of this amount, the firm paid $3.4 billion in dividends and repurchased $5.3 billion of its shares, with the remainder used to limit leverage taken on in the Sky deal. Net debt stood at $107.9 billion at the end of 2018, equal to 3.3 times EBITDA, adjusted to include Sky. The firm doesn’t expect to repurchase shares during 2019 as it works leverage lower. We expect Comcast will be able to bring net leverage below 3.0 times EBITDA by the end of the year.