Shares of ITV (LSE: ITV) edged higher this morning, despite the group warning that falling ad revenue is expected to keep profits flat this year. One reason for the positive reception may be that ITV shares have already fallen by 39% this year, so the bad news may already be in the price.
In this article I’ll explain why I think ITV could be a potential buy at current levels. I’ll also look at another television stock that’s expected to deliver strong growth next year.
Smart decisions are paying off
ITV’s third-quarter revenue rose by 5% to £2,157m, despite a 4% slump in advertising sales. This shortfall was offset by a 15% increase in non-advertising revenues, which rose to £1,252m.
This is the result of ITV’s focus on owning as much of its own content as possible. The group has acquired a string of television producers over the last few years, turning its ITV Studios business into a major revenue centre.
The benefit of this is that rather than paying royalty fees to the content producers, ITV is able to collect royalty fees by reselling its programmes to other networks. This has massively reduced the group’s dependency on advertising revenue.
ITV’s focus on its studio business has been very well timed. Advertising revenues are expected to fall by 7% during the final quarter of the year, as the slowdown seen since the referendum continues.
Despite this, management expects to hit full-year profit forecasts. These put ITV shares on a forecast P/E of 10, with a dividend yield of 5.3%. Given the group’s strong cash generation and 21% operating margin, I think ITV could be a decent income buy at current levels.
Can this stock regain previous highs?
Satellite broadcaster Sky (LSE: SKY) has been another of this year’s big losers. The group’s shares have now fallen by 29% from an all-time high of 1,140p in 2015.
I’m not entirely surprised. In my view the group’s valuation had got ahead of itself. Sky’s operating margin has fallen from a high of 18% in 2012 to just 8.2% last year. The group’s net debt has ballooned from £1.3bn in 2014 to £6.2bn at the end of June.
Of course, there are some good reasons for this. Sky’s borrowing binge was used to fund the acquisition of Sky Italia and Sky Deutschland. These are expected to help maintain the group’s growth and provide valuable extra cash flow.
Indeed, Sky’s free cash flow has always been one of its main attractions. Analysts expect the group to be able to reduce its net debt to more manageable levels fairly quickly, thanks to its strong cash generation.
For investors, Sky has a potential advantage over ITV. Whereas ITV’s profits are expected to be flat this year and in 2017, broker forecast suggest that Sky’s profits bottomed out last year, and will now rise. The satellite group’s earnings per share are expected to rise by 15% in 2016/17, and by 18% in 2017/18.
Sky’s high level of debt makes me cautious about investing. But the firm’s past performance suggests it should be manageable. With a forecast P/E of 14 and offer a 4.2% dividend yield, Sky may be worth a closer look.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended ITV and Sky. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.