Brokers Review Oz Media Sector Outlook

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This story features REA GROUP LIMITED, and other companies.
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The company is included in ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

 – Conditions remain tough for media stocks
 – Competition intensifying, cost cutting getting harder
 – Downside earnings risk leading into upcoming reporting season
 

By Chris Shaw

With advertising growth again stalling, and as the structural shift to online continues, 2012 is shaping as another tough year for the media sector in the view of Citi. Adding to the problems is increasing competition for audiences, cost inflation and in a number of cases bloated corporate balance sheets.

The news is not all negative, as Citi has identified cases of strong free cash flow generation, low capital intensity and high dividend yields. But given these are not universal qualities, the broker suggests stock selection will be important for investors.

The major themes expected to dominate the Australian media sector this year include the ongoing rise of social media and the impact this is having on marketing budgets, the cost inflation involved in the battle for TV sports rights and the growing importance of cross-selling. The strong structural position of outdoor advertising, moves to monetise online operations and the opportunities and risks involved in newspapers moving to charge for online content are also important factors.

As well, Citi is focused on the two speed advertising market, the importance of ratings in the TV sector, the check on cash returns due to bloated balance sheets, the possibility of M&A activity in the sector, a clouded employment outlook and the risk this poses to classifieds and consumptions generally and the sector focus on cost control.

Overall Citi is Neutral on the media sector outlook, as while valuations are attractive in many cases there is near-term earnings risk from a challenging economic backdrop. Relative to the market the sector is attractive but again Citi stresses the need for investors to be selective in their exposures.

Goldman Sachs is similarly cautious and for similar reasons, noting factors such as flattish ad market growth and a subdued consumption outlook are likely to limit upside potential in coming months. While traditional media companies are attempting to counter this by pursuing new revenue streams, Goldman Sachs notes there is also increased competition from social media. This and the emergence of new technology is accelerating structural change across the sector.

The developing structural changes offer a way to base exposure in the view of Goldman Sachs, the broker suggesting investors should stick with the structural winners such as the companies with strong franchise and business models and differentiated and sustainable competitive advantages.

Ad market conditions should eventually improve and when this occurs Goldman Sachs will consider chasing stocks offering the best ad market leverage. On the flip side, structurally disadvantaged stocks should be avoided as they are value traps rather than value opportunities.

Given the still difficult outlook for media companies, UBS suggests the earnings downgrade cycle has not yet run its course. To reflect this the broker has further lowered expectations for ad market growth in FY12 to just 1.0% from 2.3% previously. This flows through to cuts to earnings estimates for traditional media stocks in particular, leaving UBS below consensus with its earnings estimates across the sector by an average of 2.9% for FY12 and 3.5% for FY13.

One potential issue picked up by UBS is scope for balance sheet pressures in the sector to prompt cuts to dividends. While companies are attempting to cut costs to deal with the sector pressures in place, UBS notes this raises the risk of underinvestment in content producing a deterioration in product. This creates a death spiral, where ad revenues are negatively impacted, so meaning less funding for future content investment.

Leading into the upcoming profit season, UBS suggests Trade Me Group ((TME)) and REA Group ((REA)) have the greatest potential to beat earnings expectations. The greatest risk of earnings disappointment lies with Ten Network ((TEN)), Seek ((SEK)) and Seven West Media ((SWM)). 

Prior to results UBS has downgraded APN News & Media ((APN)), Carsales.com ((CRZ)) and REA Group to Neutral ratings from Buys previously. This leaves Austar ((AUN)), Ten Network and Seek as the broker's top picks in the sector. 

The latter two remain top picks despite material downgrade risk at the upcoming results, as UBS sees both valuation upside from current levels and strong leverage to any eventual recovery in advertising markets.

To sum up its view, Goldman Sachs rates News Corporation ((NWS)), REA Group and Carsales.com as Buys, while Fairfax ((FXJ)) is rated as Neutral and APN News & Media should be avoided.

In terms of an order of preference for the Australian plays, Citi ranks see Seek as its top exposure, followed by Seven West Media, Southern Cross ((SXL)), Consolidated Media ((CMJ)), Fairfax, Ten Network, APN News & Media and Austar.
 

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