The ITV (LSE: ITV) share price is now under 70p. The stock has now fallen by about 75% in five years and hasn’t been this cheap since 2011.
Such a dramatic slump is unusual for a FTSE 100 company. Is ITV in serious trouble, or is the market missing a bargain? Here, I’ll explain why I think the shares are a contrarian buy.
Is ITV’s share price too cheap to ignore?
ITV has two main lines of business. The first is the group’s broadcast division, which runs channels including ITV1 plus the ITV Hub. The second is ITV Studios, which makes programmes for ITV and many other television companies.
In 2019, broadcast generated roughly two third of ITV’s profits. In total, the group made an operating profit of £535m on revenue of £3,308m. That gives an operating margin of 16%, which is well above average.
Anyone buying ITV shares today can pick up the business for less than six times last year’s earnings. That’s a very cheap multiple for such a profitable business.
There are problems…
Of course, there are some problems. The coronavirus lockdown caused many advertisers to cancel planned campaigns. ITV says advertising demand fell by 42% in April. I expect the figures for May to be similar, and perhaps June too.
I think things are now starting to return to normal. But this year’s events will put a big dent in profits — analysts expect ITV’s earning to fall by about 30% this year.
I’m not too concerned about this temporary problem, which should pass. What worries me more is that ITV already had problems with advertising before coronavirus.
As more of us watch streaming television services like Netflix, advertisers are shifting their spending away from traditional broadcast TV. Last year, profits from ITV’s broadcast business fell by 17%.
Hidden value could lift ITV’s share price
To compensate for the decline in its traditional business, ITV has been expanding its Studios production business. I think this is where the shares offer real hidden value.
As well as making money from new productions and programme concepts, ITV has a huge back catalogue of content. I reckon there’s a lot of value hidden away in this business. I don’t have the in-depth sector knowledge to put a price tag on ITV Studios, but we can look at similar transactions for inspiration.
One possible clue is last year’s sale of FTSE 250 television firm Entertainment One. This company’s main asset was the popular Peppa Pig children’s series.
Entertainment One was taken over by US toy firm Hasbro for £2.9bn, or £5.60 per share. That valued the business at about 15 times trailing EBITDA (cash profits).
My sums suggest an equivalent valuation for the ITV Studios business only would value it at around £4bn. To put that in context, ITV’s entire business is currently valued at about £3.6bn.
Don’t get me wrong
I’m not suggesting ITV is going to get a takeover bid tomorrow. And the valuation could be very different to the one applied to Entertainment One. But the ITV share price looks cheap to me, however I crunch the numbers.
Broker forecasts for 2021 put ITV on 6.5 times forward earnings, with a dividend yield of 8%. I don’t know how accurate this will be, but I’m going to keep buying ITV for my portfolio.
