The Puppy Bowl & More: Discovery Communications (DISCA)

U.S. operations generate the majority of the company’s cash flow, but international operations are growing more rapidly. In the most recent quarter, cash generated by existing U.S. operations increased only 5%, while cash from international operations increased 21%. We like the growth potential and the diversification of the international operations. Growth plans include rolling out Home and Health (the leading health channel in Latin America) and Discovery Kids in Asia. (A rising U.S. dollar would, however, reduce reported earnings from international operations, because earnings in foreign currencies would be converted into fewer U.S. dollars when reported on U.S. financial statements.)

Discovery Communications has several attractive investment features, starting with its management. John Malone, a board member and large shareholder, is widely considered to be one of the savviest investors in the business. In addition, the company’s executives are focused on rate of return on investment, rather than simply on growth for growth’s sake. Third, the company generates more cash flow than is needed for its normal operations, and it has used this surplus to invest in more programming content and to repurchase shares. The number of outstanding shares has fallen by 16% over the past three years as a result of buying back stock (at average prices well below today’s price, which increases the value for remaining shareholders). Fourth, Discovery’s exceptionally high recent and prospective earnings growth is not, in our opinion, reflected in the stock’s current valuation.

We consider the stock to be suitable for growth-oriented or aggressive portfolios, due to its above-average share price volatility and the lack of a regular cash dividend. Our near-term price target is $95.

Sustainability Profile

Discovery offers programing of exceptional educational value. Discovery’s mission statement is “to satisfy curiosity and make a difference in people’s lives by providing the highest-quality content, services, and products that entertain, engage, and enlighten.”

We do have concerns over the company’s high level of executive compensation and the diversity deficit at senior levels (there is only one woman among the top nine executives and none on the board of directors). This profile is typical of the broadcasting industry, unfortunately.

Discovery’s corporate website highlights a number of partnerships with civic organizations on such issues as hunger, animal welfare, science education, and crime prevention. We are concerned by the apparent lack of any formal sustainability programs and have flagged this for future inquiry and dialogue.

Discovery Communications

Revenues: $5.5 billion

Earnings Per Share (EPS):
2014E  $3.71
2015E  $4.53

Projected 3–5-Year Annual Earnings Growth: 19%
Dividend Yield: 0%
52-Week Low – High: $72.77 – $90.76

Risk: Moderate