The Long and Short
Strong free cash flow lifts Comcast over Disney
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While both Comcast and Disney turned in strong results recently, Comcast’s significant free cash flow and relatively steady margin should equip it well to continue building its business. Comcast debt still trades wide to Disney, but the difference should start to collapse as Comcast’s advantages continue to add up.
Both Comcast (CMCSA – A3/A-/A-) and the Walt Disney Company (DIS – A3/BBB+ (p)/A-) beat Street estimates for second quarter results. But Comcast’s stronger credit and margins, free cash flow generation and full ‘A’ ratings give the company’s debt further upside relative to its peer. CMCSA still trades wide to DIS (Exhibit 1), but the trading differential should begin to collapse. CMCSA’s free-cash-flow-to-sales ratio is over 13 percentage points higher than DIS, providing CMCSA with much greater financial flexibility to pursue a host of options including shareholder remuneration, reinvestments into the business and M&A. Furthermore, CMCSA’s EBITDA margins have held up relatively well during the pandemic given the core cable business, while DIS’ margin over the same period has swung around significantly, making it more difficult to predict cash flows.
Exhibit 1. CMCSA vs. DIS Yield Curves
Source: Bloomberg TRACE; APS
Financial Metrics Stack Up Well
CMCSA’s financial metrics stack up very well relative to DIS, underscoring our view that the trading differential is set to collapse between the two credits. CMCSA’s EBITDA margins have long been maintained above 30%. While margins have contracted over the years given the increase in both competition as well as cord cutting, CMCSA’s annual EBITDA margin remains above 30%, with street forecasts looking for it to increase nearly 200 bp by 2025. This compares very favorably to DIS’ annual EBITDA margin which stood at 16.4% on a LTM basis. DIS’ margin was 30% as recently as 2018 but contracted significantly during the pandemic. Consensus estimates have DIS’ EBITDA margin growing by fiscal year end 2025, but its margin is still expected to be at least ten percentage points lower than that of CMCSA. Additionally, CMCSA’s free cash flow generation has been robust as the company ended the most recent quarter with a FCF/sales ratio 14.7% on a LTM basis, versus 1.5% at DIS. CMCSA’s free cash flow generation is a huge separating factor when comparing it to DIS.
Exhibit 2. CMCSA vs. DIS LTM Financial Metrics
Source: Company Presentations; APS
Cable Business Supports Higher Margins
CMCSA’s Cable Communications unit generated 54% of consolidated revenues in the most recent quarter and nearly 75% of EBITDA. Adjusted EBITDA at the unit was up 5.3% in the fiscal second quarter relative to revenue growth of 3.7%. That said, the EBITDA margin for the cable business expanded 70 bp year-over-year to 44.9%, a record high. Management noted that while operating expenses were up 2.5% in the quarter, programming costs fell 1.6% as video subscribers declined slightly sequentially. On a LTM basis, CMCSA witnessed net broadband adds of 775k. While broadband additions are a function of churn and connection activity, the drop off in moves this year relative to last has affected net adds despite churn being historically low. Second quarter has historically been a seasonally high quarter for disconnects, translating to an increased churn rate, as college students return home for the summer, however the pandemic has changed seasonality patterns. The seasonality changes to the business coupled with the low rate of churn helps add an element of consistency to both the top line and margins.
Leverage Now Below Target
CMCSA ended the quarter with net leverage of 2.3x, which is a tick below management’s target of 2.4x and now a half turn lower than that of DIS. Leverage is expected to hover around the current level as management has explicitly stated that maintaining a strong balance sheet is a key capital allocation priority. Maintaining leverage this low provides CMCSA with significant headroom under its current low single-A ratings profile to pursue shareholder remuneration, business investments and modest M&A activity. Based on S&P’s adjustments to debt, CMCSA has at least a half turn of leverage flexibility before it hits the 3.0x threshold for the ratings. Given the strong free cash flow generation, shareholder remuneration has been well within the confines of free cash flow, even after its 14th consecutive annual increase to the dividend and a resumption in share buybacks.
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