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Why the ITV share price rose 8.6% in September

It’s been a tough few years for shareholders in broadcaster and media group ITV (LSE: ITV). Since hitting a peak of about 280p in summer 2015, the ITV share price has fallen by more than 50%.

However, I think there could be light at the end of the tunnel. ITV shares climbed nearly 9% in September. As I’ll explain in this piece, I think these latest gains could be the start of a wider recovery.

Takeover bid suggests value

ITV hasn’t received a takeover bid. At least not yet. But FTSE 250 entertainment company Entertainment One did receive a bid in September, valuing its stock at 560p, or roughly 21 times 2019 forecast earnings.

The bid came from US toy giant Hasbro, which appears to be keen to take control of Entertainment One’s Peppa Pig brand. ITV shares surged following news of the Hasbro bid. I think the ETO deal provided the markets with a useful reminder of just how valuable ITV’s vast content library and planned new programmes could be.

It’s worth remembering that the ITV Studios business produces television for broadcasters including Netflix, the BBC and Sky. This business is not just about the ITV television channels.

The Entertainment One bid looks fully priced to me. But ITV shares are trading on less than 10 times forecast earnings. I think that looks too cheap.

Too cheap

ITV shares rose following the Entertainment One bid in September. But they’d already been on the move in August, finishing that month up by nearly 8%.

I think that August gains came because the market was starting to view the shares as oversold. Although ITV’s profits have fallen in recent years and there are concerns about advertising revenue, the business remains highly profitable.

In 2018, the group generated an operating margin of more than 18%. Return on capital employed — which compares profits with the capital invested in a company — was nearly 28%.

These are impressive figures that I’d normally associate with high-quality businesses. I wouldn’t expect such a profitable company to trade on less than 10 times earnings unless its profits were in terminal decline.

In my view, this isn’t true at ITV, where ex-easyJet boss Carolyn McCall has a clear plan to return the business to growth.

Should you buy ITV shares?

Ms McCall is making changes to the business to improve the profitability and growth rate of the group’s online viewing business. Alongside this, the ITV Studios business is continuing to develop into a major content producer.

Although the group’s debt has risen, borrowings remain at a comfortable level in my view. Cash generation still looks healthy and profits are expected to return to growth next year. At the moment, I can see no reason to expect a cut to the dividend, which currently yields 6.5%.

I’ve been holding the shares for a while now and bought more earlier this year. Although I’m not a big television watcher, I am attracted to ITV’s high returns and cautious valuation. I remain happy to hold patiently and collect dividends — although naturally I won’t complain if a bid comes along.

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Roland Head owns shares of ITV. The Motley Fool UK has recommended ITV. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.