UTV Media - a defensive value case study

I bought UTV Media back in December 2011 as one of the few small-cap companies in my portfolio. This investment has turned out to be very successful, although most of that is due to luck, which I’ll explain shortly.

The short version of this case study is that I owned UTV Media for about 7 months and it returned about 40% in capital gains, and there’s a dividend of four or five percent coming shortly. The result is down to luck because most of the gains are from the share price going up, which is a largely random event. However, picking the right sort of investment does help.

A quantitative screen

I use a quantitative process to start with, in order to reduce the vast number of potential companies (over 1,000 I think on the UK markets) down to something manageable.

In this case I rank companies by 10 year growth, the 10 year PE ratio (price to 10 year average earnings), and the current dividend yield.

Back in December, UTV media ranked highly for the combination of those three factors. The growth rate was around 5%, PE10 was very low at 5.3 and the yield was 4.6%.

The main reason that UTV appeared attractive was the exceptionally low PE10 rating. At the time the market average was nearer 12 to 14, so 5 really was very low. If those historic earnings turned out to be sustainable going forwards, then UTV shares were likely to head upwards at some point in the future.

A qualitative selection

Once I’ve homed in on a company using the quantitative stage, I like to run through a checklist so that I can get a better feel for what the company is all about. This helps me to sleep better after I’ve bought the shares, and it also stops me buying shares in companies that look good by the numbers, but in reality turn out to be cheap rubbish rather than quality bargains.

You can see my original analysis, word for word, below:

History

UTV Media is primarily a TV and Radio broadcast group. It was set up in 1959 to be the ITV license holder for Ireland and has held that license ever since. As well as TV they’re also the radio market leader in Ireland with a steak in over 20 radio stations throughout Ireland and the UK including TalkSPORT, the leading commercial talk station.

In 2005 they took on around £100m of debt to finance the purchase of the Wireless Group and radio is now the largest contributor to revenue and profits, replacing its traditional focus on TV.

Loading up with debt just before the recession turned out to be a bad idea and the company decided to do a rights issue for almost £50m in 2008 to avoid any debt related problems. That would have been painful for investors but at least it shows some level of prudence from management and a desire to avoid serious threats.

Revenues and earnings per share have been broadly maintained through the recession and I think a return to a normal dividend policy may be the main driver of returns in the medium term.

The defensive value approach contains the follow high-level steps:

Safety of Principle

1. Diversify enough, but not too much
2. Buy large, prosperous businesses
3. Avoid excessive debt

Adequate Return

1. Income – Insist on a good yield and a long history of dividends
2. Value – Pay a low price relative to long term earnings
3. Growth – Favour growing companies, but do not over-pay for them

Let’s start at the beginning and go through them one by one:

Diversify enough, but not too much

Currently the portfolio doesn’t hold any media companies so adding UTV takes us into a whole new industry.

There is little geographic diversity though as UTV is based only in Ireland and the UK. I’m not overly concerned about this as long as the portfolio contains a fair number of international companies too.

Buy large and prosperous businesses

In terms of size, UTV is as small as I will allow into the portfolio. At just over £100m it’s just over my lower limit of £100m. Although this isn’t exactly tiny it is still a relatively illiquid share with a bid/ask spread of 3%. A high bid ask spread like that can be a drag on returns as well as making it difficult to execute larger trades.

You can see the company’s performance below.

The most obvious sign of the recession is the dividend cuts from 2009. These were introduced in order to funnel cash towards the debt which had been taken on to fund the Wireless Group purchase.

Net debt peaked at £117m in 2006 and has since been brought down to £63m in the latest interim report. The debt to operating profit ratio is now around 3.3, which is well below my limit of 5 and is a relatively normal level for many companies.

Another thing to note is the stability of both revenue and earnings per share. Other than the large change between 2007/8 for revenue, where the rights issue increased the shares outstanding and therefore reduced revenue per share, the numbers are nicely stable. This gives me some confidence that revenue and earnings may be relatively stable in the future.

[note: I’ll interrupt my original analysis here to say that the chart above, which wasn’t in the original analysis, shows that my description of ‘nicely stable’ is a bit optimistic. In reality the financial output is a bit wobbly. But at least it was profitable at all times and always paid a dividend.]

All in all then I would say UTV is large-ish and steadily prosperous.

Avoid excessive debt

If it was 2007 today then I would consider UTV as having too much debt. Back then total debt stood at about £125m, while operating profit was less than £25m. That’s right on my debt to profit ratio of 5 times.

Taking on large amounts of debt to follow the acquisition trail seems to be endlessly attractive to CEOs, but often it can end in tears – as it did for UTV. Not catastrophic tears, but a 2 for 3 share split and earnings per share which are no better than they were before the take-over is not exactly a great result.

However, that was then and this is now. Debt stands at £63m and that’s almost down to management’s target of 2x EBITDA (earnings before interest, tax, depreciation and amortisation). After that target is reached I would expect to see steady increases in the dividend over the next few years, back towards a pay-out ratio of 2. This would give a dividend in the 7-10p range for a 7-10% yield at current prices.

Income – Insist on a good yield and a long history of dividends

At the moment the forward yield is 4.6%, which is about 1% above that of the FTSE 100. They have an unbroken history of dividend payments going back many years, although they did cut the dividend to divert the cash to debt payments in the recession.

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Normally I would prefer a company to have never cut the dividend, but not all companies have a progressive dividend policy like Scottish & Southern Energy which I bought last month. At least the dividend wasn’t cut to zero and the current low dividend has probably been the major driver of the current attractive price.

As I said before, I expect the dividend to recover to a much higher level than it’s at today.

Value – Pay a low price relative to long term earnings

UTV is currently trading at only 5 times the average earnings of the past decade and at about 6 times its current adjusted earnings. By any stretch of the imagination this is a low valuation for a company which is very likely to be a going concern.

At these levels I guess Mr Market’s assumption is that revenues and earnings will never recover to their previous levels because companies are increasingly finding more cost effective means of advertising using ‘new media’ and the internet. For example, an ex-equity analyst I know said that he never listens to the radio anymore, preferring his MP3’s or streaming music from the internet without ads, and that he hardly watched TV because he got most of his video media via the internet.

I think to a large extent he’s right and that TV, radio and newspapers have a lot of changes ahead of them, just like the music industry. But I don’t think we’re reached the ‘Our Price’ moment yet, when the old delivery methods disappear overnight.

I’d rather watch the TV than my laptop and I like the radio for local news and talkie programs while I’m in the car. Of course all this is anecdotal, but I just don’t see the end of ITV just yet.

Growth – Favour growing companies, but don’t overpay for them

UTV is most certainly not a growth company. In all likelihood the next decade will look pretty much like the last which means that growth will be somewhere close to zero. That’s okay though as the investment premise is based on a reinstatement of a ‘normal’ dividend distribution, as well as continued earnings around historic levels rather than spectacular future growth.

Benchmark comparison

Since the goal of the defensive value portfolio [note: this is the model portfolio from my newsletter] is to beat the FTSE 100 over period of 5 years and longer, I like to compare every new holding against that benchmark to make sure it’s up to scratch.

[Note: PEGY10 in the table above is my old ratio which I no longer use. However, I do still use the same valuation, growth and yield numbers in my initial screen]

Conclusion

UTV Media is the market leader in commercial TV and radio in Ireland, as well as having numerous radio stations in the UK. It has been a steady platform for earnings for many years, reliably paying a divided each year and generally running the company in a sustainable manner. The debt levels have more or less returned to sensible levels and so the period where debt reduction was the key issue is probably coming to an end.

That means a more normal dividend policy may return which would likely drive the share price up from where it is today. If not, then the yield should be very high which would be ample compensation until Mr Market does decide to increase the share price.

That marks the end of my original analysis.

So of course, once you’ve bought an investment, owned it for a while, received a dividend (perhaps), the next step is to decide when to sell, if at all.

In this case I needed some cash to extend the portfolio from 20 to 30 companies. However, more importantly is the reason why is sold this particular stock.

A golden goose

Imagine you bought a golden goose that laid golden eggs. Each egg was worth a hundred pounds. You bought the goose for a thousand pounds and you know that you can look forward to one egg a year.

In this case you’re getting a ten percent return on your money every year.

The thing is, your goose has a red beak, and a couple of years after you bought the goose, red beaks are all the rage. If you’re cool you have a golden goose with a red beak.

So one day a nice chap comes to your house and offers to buy your golden goose for two thousand pounds. Now, being a bit curmudgeonly and not the least bit interested in fashion, you don’t care about the red beak. You also know that you can get another golden goose, this time with a blue beak, for the same one thousand pounds that you bought your original goose, and it will still lay the same egg, worth one hundred pounds, once a year. Of course, you also know that with two thousand pounds from the sale of your red beaked goose you can buy two blue beaked geese and get two golden eggs instead of one.

That, in a nutshell (or eggshell), is sensible investing.

You aren’t speculating about what the geese will be worth in a year or two, because frankly nobody knows. What you’re doing is buying as much return for your money as you can get. If somebody offers you a sum of money for an asset (like a golden goose), and you know you can get a better return with cash than you can from the asset (in this case you can turn the cash into two blue beaked geese and get two eggs instead of one), then you sell the asset.

What does this all have to do with UTV Media? Well, quite a lot actually.

In December I picked up the shares for 104.75p. At that price the yield was 4.6%, the PE10 was 5.3 and growth (which is independent of price) was 5.4%.

On the 5th of July I sold the shares for 148p. At that price the yield was 4.4%, PE10 was 7.2, and growth was much the same.

The underlying company hadn’t really changed. Okay, the chairman had been pushed out, but how that might affect things is pure speculation (and perhaps such speculation was a big part of why the share price had gone up so much).

In essence, the higher price had weakened the dividend yield and raised the PE10 ratio (or lowered the E10 yield if you want to look at it that way). In other words, the amount of value in earnings and dividends that the shares offered for every penny invested was lower than it had been before, and was also lower than any other holding in my portfolio.

This meant that UTV Media’s shares were the worst value shares that I owned, which is why I sold them, so that I can replace them with something else that is better value; something that gives me more yields more dividends, more earnings and more growth.

Whether the shares now go on to 200p, or 300p is pure speculation.  I do not know and neither does anybody else.  But at 150p they offer far less value than they did at 100p, less than my other holdings, and less than other stocks in the market which I can replace them with.