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Morningstar | Seven West Media Shares Suffer a Big Bash as Cyclical and Corporate Euphoria Wither

After soaring over 50% above our intrinsic assessment five months ago, shares in Seven West Media have fallen back to 23% below our unchanged AUD 0.70 fair value estimate. The stock is living up to its uber-cyclical status, currently buffeted by an abrupt slowdown in the metropolitan TV advertising market in the December-half of 2018 (down around 3% year on year). This was after a solid 3.8% growth in the June-half of 2018, a buoyant start prematurely extrapolated into market valuation of Seven shares in the latter part of last year.

The pace of the downturn is such that we have cut our growth forecast for fiscal 2019 metropolitan TV advertising market from positive 2.0% to minus 1.5%. The key driver is the weaker demand from the financial sector (after the Royal Commission-related splash last year), a hiatus in government spending and a property market weakness-related cautiousness among advertisers in general. Our metropolitan TV market share estimates are unchanged for no-moat-rated Seven, being 39.3% in fiscal 2019, fading gradually to a sustainable 37.5% longer term. Better progress on efficiency drives (net cost savings around AUD 25 million in fiscal 2019, AUD 10 million higher than previous expectations) partly offsets the top-line impact.

The net effect is a circa 3% downgrade to our forward EBIT estimates, with our revised fiscal forecast growth of 6% to AUD 251 million now at the midpoint of management's 5% to 10% growth guidance. However, the small magnitude of the downgrade means our AUD 0.70 fair value estimate remains intact.

At current levels, we see value in Seven shares. Our five-year group EBIT CAGR forecast of minus 2.5% and sustainable group midcycle EBIT margin of 12.8% (versus seven-year historical average of 19.4%) sufficiently cater for the cyclical and structural risks, while Seven's financial risk is declining with forecast net debt/EBITDA forecast to fall to 1.9 times by the end of fiscal 2019, down from 2.3 times in fiscal 2018.

Another factor that drove Seven shares to as high as AUD 1.10 back in late August last year was conjecture about potential mergers and acquisition activity, along the lines of the now completed Nine-Fairfax merger. Unfortunately, Seven's recent partnership with News to launch Navigate Auto, a marketing platform encompassing both companies' various properties to penetrate the car advertising market, was hardly the kind of corporate deal the corporate activity-obsessed market was hoping for.

We have consistently been sceptical of a big-bang transaction involving Seven. The only obvious partner we can think of is News Corporation. But News effectively doubled down its bet on the subscription TV industry, via Foxtel's recent restructure (News now owns 65% of the pay TV entity). It is committed to investing in the vehicle to transform it into a hybrid operator offering traditional satellite-delivered pay TV and broadband-delivered streaming services. It would be curious, and detrimental to sentiment for its own stock, if News suddenly spent around AUD 1 billion on Seven, a free-to-air operator whose fortunes are inversely correlated with the success of a subscription TV company.

As for the details of our revised metropolitan TV advertising market forecasts, we now estimate fiscal 2019 to decline 1.5% before growing at around 1.0% per year thereafter, with traditional linear advertising challenges offset by increasing marketer acceptance of broadcast video on demand, or BVOD, offerings which are seeing 20% to 30% growth currently. We forecast Seven's share of the metropolitan TV advertising market to be 39.3% in fiscal 2019, up from 38.1% in fiscal 2018, aided by its new cricket coverage. We see this share falling to 39.0% in fiscal 2020, 38.5% in fiscal 2021 and 38.0% in fiscal 2022 before settling at a long-term sustainable level of 37.5%.