Discover Upside in DISCA

 | Dec 08, 2011 | 10:05 AM EST
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Imagine if I told you I had a large-cap recommendation with a five-year return of 35%, a company growing revenue at 15% per year with a stock that's undervalued. How about if I told you the company televises some the most popular shows on television, but isn't a major network? Give up?

Discovery Communications (DISCA) is the most widely distributed television brand in the world, reaching more than 200 countries with its programming. According to an EquiTrend study, Discovery is the No. 1 media brand in the U.S. for seven consecutive years. It's the top network for the 25- to 54-year-old demographic; its most popular shows include "Deadliest Catch," "MythBusters," "American Chopper" and Friday's No. 1 show on television, "Gold Rush."

Discovery is one of the few pure-play cable networks. The company reaches a worldwide audience of some 311 million households and more than 1.5 billion total subscribers through 142 networks in 210 countries, broadcasting in 44 languages. The company's brands include Discovery Channel, Planet Green, TLC, Animal Planet, Science Channel, Investigation Discovery, and a 50/50 partnership with Oprah Winfrey for the Oprah Winfrey Network (OWN).

I expect revenues to grow 15.5% in 2011 to $4.27 billion and another 8%-9% in 2012, which is slightly ahead of management's guidance from this week's UBS Media Conference. The growth is coming from strong U.S. networks performance (revenue up 11% YTD) and the fast-growing international network business (up 18% YTD). Year-to-date, the advertising business is up 12% and video distribution revenue is up 15%.

Margins are up too. Full-year adjusted margins in the U.S. business are up 100 basis points to 58% and international margins have gone from 39% to 44% in the last year. Total company margins are up 200 basis points to 45%.

Earnings before interest, taxes, deprecation and amortization are likely to grow 16.5% in 2011 to $1.94 billion and 13%-14% in FY12. Earnings per share (which includes a $2 billion stock buyback) are estimated to be $2.39 in FY11 and $3.00 next year.

I believe Discovery could be a $50 stock by this time next year (up from $41.79 today) simply because of strong free-cash-flow generation, increasing margins, growing international markets and high television ratings. To understand the earnings momentum the company has, all you have to do is look back. In FY06, the company lost $0.32 a share and had revenue of $688 million. Today, revenue is expected to be over $4 billion.

Investors looking to discover profits should take a look at Discovery Communications.

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