EUR 850.00 For Business Accounts Only

Morningstar | Hell's Kitchen of an Advertising Market but Seven Progressing on Matters within Own Control. See Updated Analyst Note from 23 May 2019

We view Seven West Media's recent earnings guidance downgrade as mostly a cyclically driven event. The advertising market is feeling the effects of a sluggish economic backdrop. Despite the one-off boost from election-related expenditures, marketing spend on free-to-air TV is tracking down mid-single-digit percentage points in the current June-half to-date. To make matters worse, a tough prior-year comparison (Commonwealth Games) and lack of sizzle from the MKR franchise have impacted Seven's TV ratings/revenue share in the current half.

As such, our fiscal 2019 EBIT forecast has been cut by 11% to AUD 210 million, the bottom of management's revised projection range of between AUD 210 and 220 million. The practice of conservative forecasting relative to management projection has served us well in the past and we believe will continue to do so in the future. However, our forecasts beyond fiscal 2019 are largely unchanged and our AUD 0.68 fair value estimate for the no-moat-rated group remains intact.

Shares in Seven have lifted 7% since unveiling the bad news, a rather peculiar reaction to a 10%-plus downgrade to management's previous earnings guidance. This could be market apathy or that a point of maximum pessimism has been reached with Seven. Or perhaps investors are willing to look through the near-term cyclical issues. We certainly are, and continue to see upside in Seven shares, trading at a 21% discount to our midcycle intrinsic assessment.

Our confidence is supported by the solid progress in areas that are within management's own control. Group costs are on track to reduce by close to AUD 40 million in fiscal 2019. While the near-term earnings hiccup has halted the balance sheet deleveraging process, net debt remains on course to reduce by AUD 75 million, and our forecast net debt/EBITDA of 2.3 by the end of fiscal 2019 is still well below 4.0 covenant limit. Assuming earnings recover as we expect, net debt/EBITDA is heading below 2.0 in fiscal 2020.

Delving further into our near-term earnings forecast downgrade, we now expect the metropolitan TV advertising market to decline 4.5% in fiscal 2019, from negative 1.5% previously. The market is then forecast to grow at a CAGR of 1.5% thereafter, with traditional linear advertising challenges offset by increasing marketer acceptance of broadcast video on demand, or BVOD, offerings which are seeing 30% to 40% growth currently. We forecast Seven's share of the metropolitan TV advertising market to be 38.8% in fiscal 2019, down from 39.3% previously, impacted by weaker-than-expected ratings in the face of "Married at First Sight"-led Nine. We see Seven's revenue share picking up to 39.0% in fiscal 2020, 38.8% in fiscal 2021 and 38.5% in fiscal 2022 before settling at a long-term sustainable level of 37.5%.

In terms of earnings, our five-year group EBIT CAGR forecast for Seven is minus 3.0% and sustainable group midcycle EBIT margin is 12.8%. This compares to the group's seven-year historical average of 19.4% and sufficiently caters for the cyclical and structural risks. Based on these forecasts, we expect net debt/EBITDA to settle around 2.0 times from fiscal 2020, with dividends reinstated from fiscal 2020, albeit at just AUD 0.02. Dividends are then forecast to increase gradually to reach AUD 0.04 by fiscal 2022, on a payout ratio of around 50%.

Our forecast already incorporates the AUD 21 million Seven is expected to receive from the sale of its 50% interest in Yahoo7 to Verizon Media. While it may not be much, every dollar helps in management's debt-reduction focus. Seven's liberation from the Yahoo Venture also means the group is now in full control of all its online properties, and allows management full freedom to monetise and harvest the fast-growing BVOD business.