Comcast Stock: After A 40% Rally, Is It Time To Lock In Gains? (NASDAQ:CMCSA)

Introduction

Shares of Comcast Corporation (NASDAQ:CMCSA), for which I issued a strong buy rating on Oct. 5, 2022, have rallied more than 40% since hitting a 52-week low of $28 that same month. Disciplined investors who have averaged carefully into their positions over the past year may therefore be wondering if it’s time to lock in some profits in anticipation of renewed selling pressure early in 2023 and now that 2022 full-year results are on the table.

Understandably, it hasn’t been an easy year. Comcast’s cable business (which remains the key cash flow driver) is struggling to grow, due in part to competition and inflationary pressures. Add to that uncertainties in China (Comcast owns Universal Beijing Resort, UBR), fierce competition in streaming services (Comcast owns Peacock), and difficulties in its Sky segment overseas, and it’s easy to see why Mr. Market was quite depressed about the stock.

In this update, I will share my view on the company’s operating performance in 2022 and whether Mr. Market has indeed become overly optimistic about the stock. I will also present an updated valuation and elaborate my position.

Comcast 2022 Performance

For the final quarter of 2022, Comcast reported adjusted earnings per share (EPS) of $0.82, beating estimates by $0.04. For the full year, the company reported adjusted EPS of $3.64, up nearly 13% year-over-year. That sounds spectacular for a company primarily in the cable business. Excluding share repurchases (the company spent more than $13 billion on buybacks this year), earnings growth would have been about 7% – still very respectable. The company has increased its dividend by 7.4% (15^th consecutive increase), which is certainly welcome in times of high inflation. Remember, inflation is not being beaten by stocks with high yields, but by those with dividend growth above the rate of inflation.

Unadjusted operating cash flow for the year was $26.4 billion, down 9% from a year ago. This was due to lower cash earnings and changes in operating assets and liabilities other than accounts payable and accounts receivable, which were in line with 2021. The main adjustment to arrive at the non-GAAP earnings per share of $3.64 mentioned above was an $8.5 billion impairment charge for goodwill and long-lived assets related to Comcast’s Sky segment (I covered the segment in this article). From a cash flow perspective, it is unfortunate that the goodwill impairment was primarily not tax deductible. Stock-based compensation was largely in line with 2021 at about $1.34 billion. Comcast is definitely one of the companies with significant stock-based compensation (Figure 1), but of course nothing like Alphabet (GOOG, GOOGL), for example (see my analysis of Alphabet’s cash flow). Capital expenditures and intangible asset cash outflows increased 14% year-over-year, driven by investments in broadband, 10 gigabit network upgrade, wireless communications, and Peacock. Cash outflows not included in regular capital expenditures were $330 million attributable to construction at UBR, a significant decrease from $980 million a year earlier.

For these reasons, it is hardly surprising that free cash flow, normalized with respect to working capital movements and stock-based compensation (nFCF), declined by about 33% year-over-year, but was still respectable at nearly $11 billion. Comcast’s cash outflow due to dividend payments of $4.7 billion still compares favorably to the somewhat weaker nFCF this year, i.e., a payout ratio of 43%, compared to 30% on an adjusted EPS basis. My regular readers know that I do not rely on adjusted EPS-based dividend payout ratios, and this example clearly shows why.

Comcast’s Cable Communications segment posted net additions of 250,000 customers in 2022, understandably down significantly from 1.3 million in the prior year and the primary reason for Comcast’s poor stock performance in 2022. I don’t expect strong growth going forward, but I’m confident the company can defend its moat around its high-speed cable offerings. DOCSIS 3.1 technology was introduced about five years ago and allowed the company to offer gigabit speeds with relatively little capital outlay. Comcast continues to work on implementing DOCSIS 4.0, which uses the full spectrum of the cable plant in both the downstream and upstream directions and enables 10 gigabit connections. The company will offer this technology over its network in the second half of 2023 but has already began the rollout. I do not expect 5G offerings to pose a significant threat as scaling remains a challenge in terms of data volume, but competition from T-Mobile (TMUS) and Verizon (VZ) is intensifying.

Net additions of wireless customer lines were 1.3 million, slightly better than last year, but the segment is still quite small with only about 5.3 million lines. Year-over-year growth at the NBCUniversal segment (5%) was largely due to the solid performance of Comcast’s theme parks, but of course the lockdown measures in China weighed on Universal Beijing Resort’s numbers. Growth at Peacock was solid, with over 20 million paying subscribers now (up over 100% year-over-year), but the service is obviously still a small player in this space compared to Netflix (NFLX) and others and continues to burn cash (adjusted EBITDA loss of $978 million). For me personally, Peacock plays an insignificant role in my investment thesis, as I consider the streaming business to be largely commoditized and ripe for consolidation.

CMCSA Stock Valuation And Concluding Remarks

The 40% recovery looks spectacular at first glance, but it should be remembered that CMCSA reached an all-time high of over $60 in the third quarter of 2021. According to the FAST Graphs chart in Figure 2, which is based on adjusted operating earnings per share, the stock still appears to be severely undervalued at $40.

However, considering Comcast’s growth through acquisitions and regular share buybacks (see above), I believe a valuation based on enterprise value (EV) is more appropriate. To provide a more transparent view of actual earnings, I have also included normalized free cash flow on a company basis rather than a per-share basis.

Comcast’s net debt has been declining – slowly but surely – since the acquisition of Sky in 2018 (around $50 billion). At the end of 2022, Comcast had about $101 billion in net debt (including estimated lease obligations) on its balance sheet, up about 4% year-over-year, due to above-average cash returns to shareholders. As a reminder, the company repurchased more than $13 billion worth of stock, paid nearly $5 billion in dividends, but generated only $11 billion in nFCF. This underlines why I prefer to value the company on an EV basis. Figure 3 compares Comcast’s EV to its nFCF before interest in a similar fashion to Figure 2. As an aside, since enterprise value takes into account the entire capital structure, it must be compared to nFCF before interest. For the sake of brevity, I did not take into account tax effects (interest payments are tax deductible).

I would argue that free cash flow will recover in 2023, and growth will come primarily from price increases and only a very small amount from customer growth. As long as Comcast is able to defend its top position and economic moat, I imagine its pricing power will remain intact. Competition from telephone companies will increase, but I think Comcast will continue to expand its footprint, solidifying its position in previously untapped domestic regions. NBCUniversal and Sky are welcome diversifiers, and NBCUniversal’s revenues should continue to recover nicely thanks to rising attendance at theme parks. Peacock will also help once it becomes cash flow positive, but one should not forget that the streaming business is highly competitive. That said, I think Comcast has very lucrative content franchises to offer, with Jurassic World and Despicable Me, as well as the DreamWorks assets. I am not particularly optimistic about Sky, as competition in that space is extremely fierce.

All in all, however, I remain confident and continue to think the stock is undervalued, even though I think Morningstar’s $60 fair value estimate is a bit optimistic given the weak growth outlook. In this context, I would like to share with you my discounted cash flow (“DCF”) sensitivity analysis based on Comcast’s probably somewhat pessimistic three-year average nFCF (Figure 4). If Comcast grows its free cash flow at a CAGR of only 1% in perpetuity, investors who are comfortable with an 8% cost of equity are currently paying a fair price. Indeed, 1% growth seems very modest – the company has grown its nFCF at a CAGR of 3.8% over the past decade, comparing 2012 and 2022 nFCFs.

In light of the still very reasonable valuation, management’s shareholder-friendly stance, reliable cash flow, moderate dividend payout ratio, and manageable debt, as I highlighted in my previous article, I am holding onto my Comcast Corporation position and will even consider adding to it in case of weaknesses.

Thank you very much for taking the time to read my article. How did you like it, my style of presentation, the level of detail? If there is anything you’d like me to improve or expand upon in future articles, do let me know in the comments section below.