Discovery Outgrowing The Competition

By Ryan C. Fuhrmann | May 22, 2012 AAA

Discovery Communications (Nasdaq:DISCA) (Nasdaq:DISCB) owns some of the most appealing and impressively growing channels in cable. Over the past several years, it has been able to report steady sales growth and very impressive annual profit gains. With a few more years of similar trends, the stock could continue to keep pace with the underlying business growth.

SEE: Will Digital TV Allow You To Ditch Cable?

First Quarter Recap
Revenues advanced 16% to $1.1 billion. Discovery earns revenues from advertisers and distribution fees from outside cable and television providers. For the quarter, growth in these two primary areas was 19 and 16%, with the revenue breakdown at 50 and 48%, respectively.

U.S. network revenue also increased 16% to $681 million, or nearly 62% of the total top line. This stemmed from the nine wholly-owned networks that include the namesake Discovery Channel, TLC, Animal Planet, as well as stakes in the Oprah Winfrey Network and a couple of other networks. International grew slightly faster at 17.2% to grow to over 34% of total revenue. Discovery operates in over 200 countries and territories outside of its home market. Educational accounted for the rest and was about flat at $42 million.

Reported operating income fell 12% to $446 million, but last year's quarter contained a $129 million gain from disposing of some media assets. This flowed through to a net income decline of 27.3% to $222 million, or 57 cents per diluted share. Backing out the gain last year, management estimated profit growth at 9% and reported free cash flow of $227 million, which exceeded net income.

SEE: Free Cash Flow: Free, But Not Always Easy.

Outlook and Valuation
For the full year, Discovery projects total revenues between $4.5 billion and $4.65 billion and net income of around $1 billion. Analysts expect sales growth of nearly 9% and earnings of $2.77 per share. For the following year, they expect sales growth of 7% to almost $5 billion and earnings of $3.36 per share, or annual growth of 21.3%. This puts the forward earnings multiples at 17.4 and 14.3 for this full year and 2013.

The Bottom Line
The past few years have seen respectable, mid-single-digit revenue growth at Discovery, but it has been able to leverage this into average profit growth of around 40%. Free cash flow has also grown rapidly and exceeded $1 billion last year, or $2.67 per diluted share. The forward earnings multiples are not overly appealing, but a couple more years of similar bottom-line gains would push the valuation into reasonable territory.

Discovery has a solid chance of continuing its rapid profit growth. Larger rivals including Disney (NYSE:DIS), News Corp (Nasdaq:NWSA) (Nasdaq:NWS) and Viacom (Nasdaq:VIA) (Nasdaq:VIAB) report annual sales as much as 10 times larger than Discovery. There is also upside potential should the Oprah Winfrey Network eventually take off. International growth should also remain strong well into the future.

SEE: Walt Disney: How Entertainment Became An Empire

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

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