Last October, we suggested taking some profits in Time Warner Cable (TWC) as its share price neared $100. We thought that the company had many attractive investment attributes, including a good business with recurring cash flow, a likely tailwind from new household formation and a solid management team. But at $100, a lot of what we liked was priced into the stock.
Now that the stock has pulled back to $88, we believe it's time to start rebuilding our position in Time Warner Cable.
The shares have fallen almost 13% since the company released earnings on Jan. 31. It wasn't a bad earnings report, but since the stock was trading at over $100, there was no room for disappointment, and the numbers regarding subscriber trends, profit margins and free cash flow were below analysts' expectations. Here is where the report fell short:
High-speed data subscriber additions came in at 75,000, compared with expectations of over 100,000. Some of this may be attributable to the combination of a new $3.95 modem lease fee and to aggressive promotional pricing by the telecom companies. Whatever the reasons, it was a disappointment in the company's best business and primary contributor to growth.
Video subscriber losses were more or less as forecasted, but there had been some hope that Time Warner Cable would do better, especially in light of the improved video trends that Comcast (CMCSK) has shown recently. (Comcast will report earnings on Wednesday.)
Management lowered margin guidance because of higher programming costs (up 10%) and pension costs (up 20%) and the absence of political advertising (the latter two issues should not be comparative in 2014).
Flat free cash flow guidance was disappointing, in part because of higher cash taxes.
All of the above resulted in some analyst downgrades, reductions in price targets and a sharp selloff.
We like the stock at today's lower price. Yes, there is a hiatus in free cash flow growth in 2013, and the subscriber metrics and reduced margin guidance were disappointments, but we believe that patient investors will be rewarded by investing in Time Warner Cable at the current share price. It's still a great company with a growing stream of recurring revenue that offers products that consumers will pay a premium for, even during a recession.
Housing markets and employment trends are improving, and it's only a matter of time before new household formation results in better cable subscriber trends. The company remains focused on its business strategy and is committed to returning capital to its shareholders. Time Warner Cable should deliver double-digit earnings growth in 2013, and it raised its dividend by 16% to $2.60 per share.
At today's price level, an investor gets a 9% free-cash-flow yield and a 3% dividend yield. At the first sign of good news, we believe the shares can move back to over $100 again.
The recent selloff gives investors the opportunity to reinitiate a position in a quality franchise at an attractive price.