STV is James Faulkner’s Small Cap of the Week

A rising dividend can send a clear signal to the market in terms of the trajectory management foresees for future trading. With this in mind, I thought it worth taking a look at STV Group (STVG), which returned to the dividend list in 2013, after a long period in the wilderness due to debt problems.

The business…

But first, a bit of background. STV is the Channel 3 (ITV) franchise holder for Scotland, achieving around 4.2 million viewers per month. The company is organised into two divisions, STV Consumer (Broadcast and Digital) and STV Productions. While ITV plc is responsible for network programming and national airtime sales, STV’s licence requires it to produce a minimum level of dedicated regional programmes, including news – a quota it always exceeds. STV’s Consumer division delivers the full programme schedule via digital terrestrial, cable and satellite television in Scotland (including separate sub-regional services) and it also delivers content to all digital channels: online (including ‘catch-up’ TV), mobile and connected devices. Meanwhile, STV Productions creates and produces programmes for broadcasters in the UK and overseas, including the BBC, ITV and Channel 5.

Like many of its peers, STV had a tough time during the recession. Since the turn of the millennium the firm grappled with problems of strategic overstretch, debt and the structural downturn of the advertising market. By 2006, net debt, at £157 million, was a whopping 9x EBITDA. However, a new management team arrived in 2007 and immediately set about refocusing the company, with a particular emphasis on digital media. A £95 million rights issue in 2007 helped ameliorate the problem, but debt subsequently increased up to 2011 due to ongoing losses before businesses could be sold off and the cost of ITV litigation (see below). However, debt is now on a steeply declining trajectory, with a net debt/EBITDA ratio of 2.3x in 2012 set to falls to below 1x in 2015.

Another reason investors have stayed away from STV is its long-running history of litigation with ITV over programming and digital rights. Although this was settled in 2011 for £18 million in ITV’s favour, it was not a complete defeat from STV’s perspective. On the plus-side, STV had its digital rights position confirmed thus giving it ‘sovereignty’ over all platforms and channels in its licence areas. In practice, this means that Scottish residents wanting to watch video content ‘on-demand’ (VOD) have to go through the STV Player rather than through ITV. This is great news for STV, as the STV Player is high margin because the programme costs are already sunk (often by ITV). Meanwhile, the new affiliate agreement that came out of the settlement sees STV pay a set fee for ITV programmes, bestowing it with stable and predictable cashflows.

Multiple avenues for growth…

In 2012, Broadcast (which encompasses airtime sales and sponsorship) generated 89% of EBIT, but management aims to grow non-broadcast earnings to 33% of the total by 2015. Generating an annuity-like income stream of c.£20 million a year, the ITV franchise licence represents a solid foundation upon which STV can build out its revenue-generating capabilities. Being the leading Scottish commercial broadcaster since 1957, STV has an excellent opportunity to capitalise upon its unrivalled knowledge of its audience and use this to access new revenue streams.

STV’s website, stv.tv, is Scotland’s most popular commercial online destination boasting 3.2 million unique visitors per month. As well as the usual catalogue of news, entertainment and sport one would expect from such a portal, the company has also been experimenting with new forms of content such as bingo. Already being available through the entire stable of platforms – YouView, iPhone, iPad, Android and PS3 – stv.tv is perfectly positioned to take its evolution to the next level through implementing new social media tools from Gigya (which is all the rage in the US broadcast and media market where it counts 90% of the leading companies among its clients). Due to be launched shortly, this will allow for much more innovative interaction with consumers (e.g. gamification) and more data mining.

STV is already Scotland’s largest commercial TV production business, but it aims to double revenues from this channel to £20 million. It has the partnership channels in place to do this given recent commissions from the BBC, UKTV and Channel 5, not to mention ITV which is more friendly now that litigation has ended. As well as generating ideas internally, STV collaborates with independent production companies and has a rather exciting deal with a US production company, Kinetic Content, which allows both companies to exclusively license each other’s original formats. Although STV’s programmes are initially very low margin (c.2%) due to the fact that costs are borne upfront, they represent a long-term investment which pays incremental returns as the back catalogue is accessed by other broadcasters. STV’s library currently generates around £1.5-2 million of high-margin revenues a year (including £1.1 million overseas).

Recent trading…

Recent interims showed revenues up by 7% at £54.7 million for the six months to June, with pre-tax profits rising by 35% to £8.4 million. Net debt was cut by 8% to £40.1 million over 12 months but was up from £35.7 million at the end of December, mainly due to higher levels of capital investment and seasonal working capital outflows. While the cash flow from operations was £6 million for the period, interest and pension deficit payments took the inflow neutral. STV stated that it is on target to achieve a net debt/EBITDA ratio target of less than 1.5 times for the year end. However, the standout development – and a clear sign of management’s confidence going forward – was the doubling of the interim dividend to 2p per share, and the commentary from management that it intends to make a final payment for the year of 4p per share. The represented a doubling from previous guidance, with the company planning to increase the dividend by a further 33% in 2015 – implying an 8p payment.

At the operating level, broadcasting business STV Consumer saw revenues grow by 9% at £50.8 million as advertising revenues improved and digital revenues grew by 16%. Operating profits grew by 25% to £10.9 million, with margins rising to 21.5%, up from 18.7%. Flagship channel, STV, achieved peak-time performance of 0.4 share points in excess of the network during the period, with monthly streams to the STV Player up by 14% year on year and downloads of the STV Player app up by 66%. Elsewhere, city TV service, STV Glasgow, launched in June reaching almost 650,000 viewers on average in the first two months, 33% of the available audience. There is said to have been a positive response from advertisers and commercial partners, with 60% of advertisers in the first three months representing new customers to STV. The launch of second city based service, STV Edinburgh, is on track for January 2015. On the outlook, STV stated that national airtime revenues are expected to continue to perform in line with the market during Q3, with a cumulative forecast to the end of Q3 up 7% year on year. In the regional market the forecast is for up 6% year on year and digital revenues are expected to continue to grow by 15%-20% for the full year.

Meanwhile, production business STV Productions saw revenues fall by 15% to £3.9 million with an operating loss of £1.1 million, up from £0.5 million. However, the full year revenue target of £16.8 million is said to be on track, up from £13.5 million in 2013, with the majority of programmes being delivered to broadcasters in the second half of the year. Operating highlights include 40 episodes of daytime quiz show, The Link, being commissioned for BBC One following a successful run of 25 episodes. Re-commissions have also been announced for a third series of Catchphrase for ITV, four series of Antiques Road Trip for BBC One, a fourth series of Celebrity Antiques Road Trip for BBC Two and a second series of The Lie for both TV3 and STV.

What’s it worth?

With advertising revenues rising, new ventures looking to be performing well and net debt expected to continue to fall, the outlook for STV looks promising. Moreover, the recent ‘No’ vote in the Scottish Referendum has removed a key element of uncertainty from the shares, which haven’t really made any progress since the vote. Market consensus forecasts for the current financial year are for pre-tax profits in the region of £17.5 million and earnings of 38p per share.

This puts STV on a rating of 9.6 times, which continues to be a significant discount to larger rival ITV, which trades on around 15.6 times consensus forecasts for 2014. Assuming that the 6p dividend is paid for the full year the yield is 1.64%, rising to 2.19% in 2015 assuming an 8p per share payment. While the current yield on offer is modest, the appears scope to grow the dividend significantly in the coming years. This, along with a continued steady reduction in gearing, suggests the outlook for the equity remains positive.