If the deep-pocketed streaming behemoth Netflix is struggling to get more viewers to tune in, what hope does ITV have? The US tech group is losing share to digital rivals despite the billions of dollars in cash it is throwing at content; the homegrown broadcaster is financing its latest push into on-demand viewing, ITVX, with cash generated by inconsistent advertising revenue and an already capital-intensive Studios business.
Second-quarter guidance for a slowdown in ad revenue shows exactly why the ITV chief Carolyn McCall is searching for a way to reduce its reliance on marketing budgets. Total ad revenue is expected to be 6 per cent lower than the same time last year, against an annual 16 per cent rise for the first quarter.
Last year’s Euro football finals provide a tougher comparator, but the threat of cautious advertisers — feeling the pinch from inflation — deciding to cut spending presents a bigger risk to what is a key revenue stream for ITV.
A pathetic-looking forward price/earnings multiple of just over five is as weak as that recorded amid the March 2020 sell-off, but investors shouldn’t take pity on ITV. The shares have fallen by 40 per cent since the start of this year, but there is scope for more disappointment.
The launch of ITVX, which will replace the ITV Hub and ad-free service ITV Hub+, later this year is fraught with risk. McCall’s lofty plan is that the new platform will help to double digital revenues to £750 million by 2026, driven by a doubling of monthly active users to 20 million and subscribers to 2.5 million. The cost? Roughly £65 million will be spent on the launch, content and streaming data and technology this year, rising to almost £200 million next year. Funding won’t be an issue. ITV has cash and available debt facilities of £1.5 billion and generated £407 million in free cash last year. But it does mean that profitability is likely to take a hit, with analysts at the brokerage Shore Capital forecasting adjusted pre-tax profits of £725 million and £625 million this year and the next, lower than the £746 million reported last year.
The hope is that ITVX will be self-sufficient in four years’ time. But that relies on winning the battle for eyeballs against much larger streaming platforms, enough to lure more advertising spending and paying subscribers. If it can’t, the question is whether management becomes tempted to throw more money at ITVX to win over viewers.
Covid aside, ad revenue has fallen on an annual basis more times than not during the five years to 2020. The Studios business might look like a surer long-term bet for revenue growth, but costs including labour and studio space make the division a lower margin one. So while Studios revenue accounted for 44 per cent of revenue last year, it generated only 26 per cent of adjusted earnings, on a margin of 12 per cent. That is not expected to increase by any great level any time soon, with management targeting a margin of 13-15 per cent over the medium-term.
To think that ITV is worthy of buying on the share price weakness you would have to believe that over the medium term, growth in Studios and digital revenue can mitigate shaky advertising revenue and the cost of ensuring the streaming platforms draw viewers in.
ITV looks like a prime candidate for being booted out of the FTSE 100 in the next reshuffle of the index, which would see more institutional investors heading out the door. The difficulty in competing with streaming giants has seen a for-sale sign hoisted above Channel 4. The best chance for a re-rating in ITV’s shares might be takeover interest.
ADVICE Avoid
WHY Unpredictable advertising revenue and the cost of digital expansion could weigh on profitability for longer than expected
Compass Group
Keeping a rein on costs by reducing menu options and switching to cheaper meats, while also keeping customers happy, is a fine line for Compass to tread as inflation ratchets up.
But it is one the catering giant is managing thus far, winning enough new business to offset the reduction in underlying contracts, which generated 15 per cent less revenue than prior to the pandemic.
The result? Revenue that is back at pre-Covid levels, half-year profits that were ahead of market expectations and an organic revenue growth target of 30 per cent for the full year, above the 20 per cent to 25 per cent previously expected.
Free cashflow of £360 million is almost twice that reported this time two years ago, which coincided with the unveiling of a £2 billion fundraising aimed at bolstering the balance sheet ahead of stormy trading. Management has announced plans for a £500 million share buyback, which analysts at Shore Capital reckon could be the first of more special returns to come.
Worsening inflation is now the major risk to hitting a margin target of 7 per cent at the full-year, which would be nearing the 2019 level. So far Compass has managed rising costs partly through increasing prices by between 4 and 5 per cent.
However, the chief executive, Dominic Blakemore, “won’t trade margin for growth”. If the group can keep recovering revenue from pre-existing clients, then together with new contracts, that could leave Compass a larger business than pre-Covid, he reckons.
Perhaps that explains the shares’ forward price/earnings ratio of 22, ahead of the multiple recorded in the eight years prior to the pandemic hitting.
True, the group has been winning new business at a faster pace than historical norms, at 6 per cent growth versus the 4 per cent to 6 per cent rate it typically records.
But is that proof of more companies realising the potential cost benefits of outsourcing their catering, or a natural consequence of more organisations restarting their food service after a lockdown hiatus, as more staff return? The answer will not be clearer until next year.
ADVICE Hold
WHY A high rating leaves the prospect of further recovery already priced into the shares
