STV Group — Update 26 August 2016

STV Group

New KPI targets reflect confidence

Interim results update

Media

26 August 2016

Price	368p
Market cap	£144m

Net debt (£m) as at June 2016		29.1

Shares in issue	39.5m
Free float	93%
Code	STVG

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	16.0	5.4	(16.7)
Rel (local)	13.3	(3.4)	(27.5)

52-week high/low

515.0p

304.0p

Business description

STV is Scotland’s leading media brand. It holds the Channel 3 (ITV) commercial television licences for Scotland and creates and distributes programmes across all platforms, including broadcast and catch-up TV, online, mobile and connected devices.

Next events

Q4 trading update	December 2016
Full year results	February 2017

Analysts

Bridie Barrett	+44 (0)20 3077 5700
Jane Anscombe	+44 (0)20 3077 5740

media@edisongroup.com

Edison profile page

STV Group is a research client of Edison Investment Research Limited

A strong performance from the higher-margin regional and digital sales has enabled STV to drive strong growth in operating profit. The interim and full year dividend have been increased by 33% and 20% respectively and new KPI targets for 2018 introduced to support STV’s ongoing strategy to diversify the group’s broadcast franchise.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
12/14	120.4	17.3	37.6	8.0	9.8	2.2
12/15	116.5	19.1	38.8	10.0	9.5	2.7
12/16e	124.9	20.8	42.1	12.0	8.7	3.3
12/17e	132.2	22.8	45.9	14.0	8.0	3.8

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Strong operating margins

H116 results were broadly as flagged in the April trading update. Revenues grew 5% to £56.2m. Growth was skewed towards the high-margin digital and regional airtime sales, enabling operating margins to expand to 19.6% from 16% in H115 and operating profit increased 28% to £11.0m. The IAS 19 valuation of the pension deficit has been increased by £39m, however, this should not impact cash funding of the scheme, which is already based on more conservative assumptions (the outcome of the schemes triennial valuation is expected in Q3). An interim dividend of 4p has been announced (+33% y-o-y) as has the intention to increase the full year dividend 20% to 12p.

New KPI targets demonstrate confidence

The near-term outlook for STV holds no surprises: national airtime sales are expected to be weak in Q3 (-6%), owing to the strong contribution from last year’s Rugby World Cup, rather than any impact from Brexit, where management say that until now there have been no signs of changes to customers’ plans. This should be offset by ongoing strength in regional airtime and digital sales, and a resurgence in production sales; 2016 forecasts look fairly secure. Management has also introduced new KPI targets for 2018, against which it benchmarks the group’s progress. This demonstrates an ongoing commitment to expanding non-broadcast share of earnings as well as driving margins in the consumer division. We trim our revenue forecasts by c 2% but make no change to our forecast EBIT or EPS.

Valuation: In robust condition

STV continues to demonstrate its ability to extract value from its strong Scottish brand, where 56% of Scots now use at least three STV services. The uncertainty over the British economy that has been left by Brexit casts a shadow over all UK advertising companies. However, STV’s share price, which is at a 30% P/E discount to its closest UK peer ITV, should be supported by the cash generation of the business, a progressive dividend policy and the fact that it is less exposed to a ‘shock’ to advertising than other commercial broadcasters due to the affiliate nature of its relationship with ITV.

Interim results highlights

Exhibit 1 breaks down the H1 results and our FY16 and FY17 forecasts (to which we make no significant changes) in more detail.

■

Consumer revenues increased by 2% overall despite a 1% reduction in national advertising revenues, as expected. This was driven by the continued strong growth (25%) from digital (predominantly the STV player) and regional sales (+24%), which are increasingly being sold as a bundle with City TV (reporting flat revenues – lower than expected, but compensated by a higher regional performance). These two categories have considerably higher margins than national airtime sales and the consumer operating margin consequently increased to 22.4% (from 18.7% in H115). The divergence in performance in national vs regional airtime sales is partly explained by the weak first-half last year in regional sales (and a stronger national performance). Looking out to the second half of the year, management expects a broadly similar pattern of performance; national airtime sales in Q3 point to a 6% contraction, however, regional remains very strong (+20% y-o-y to September), as is digital (+25% expected in Q3).

■

STV productions reported a doubling of revenues on H115. The first half is typically much smaller for commissions and the division remained loss making, although slightly less so than in H115. The second half of the year is seasonally more significant and with strong bookings reported, we expect a recovery of revenues and profitability to 2014 levels for the year as a whole. In addition to successfully renewing its flagship franchises, new commissions include ‘The Dressing Room’ (UKTV – six episodes and the first project to be developed under the strategic agreement with Group M announced last year), a second series of Prison (Sky1) and Stopping Scotland’s scammers (STV) as well as a number of documentaries where STV’s reputation continues to grow: The Queen Mary (BBC4), Life After Chernobyl (Animal Planet) and a four-part documentary for Channel Five – Tour de Celeb.

■

Pension update: The triennial valuation of the pension scheme is expected to conclude during Q3. The mortality studies conducted as part of the review indicate an improvement in life expectancy and the board has increased its estimate for the IAS 19 calculation of the deficit by £39m to £53.9m. This does not impact the funding valuation, which includes a larger level of prudence in setting actuarial assumptions and the annual funding contribution is not expected to change materially from current levels.

■

Net debt at the end of June was £29.1m, up from the £25.7m reported at year-end 2015, mainly due to the timing of the annual £7.8m pension funding payment, which was made in January for the year.

Exhibit 1: STV H1 2016 results and forecasts

£m	H115	2015a	H116a	y-o-y change	2016e	2017e
National airtime NAR	38.9	78.6	38.5	-1%	77.8	78.6
Regional airtime NAR	5.3	13.4	6.6	24%	15.8	16.6
City TV	0.4	1.0	0.4	0%	1.1	1.3
Digital	2.8	6.6	3.5	25%	8.3	10.3
Sponsorship	2.5	5.2	2.6	4%	5.4	5.3
Other	2.0	3.5	1.1	-44%	2.6	2.1
Total Consumer	51.9	108.2	52.7	2%	110.9	114.2
Productions	1.7	8.3	3.5	106%	14.0	18.0
Revenue: Total	53.6	116.5	56.2	5%	124.9	132.2
EBIT: Consumer ex digital	8.7	16.7	9.9	14%	16.6	16.8
EBIT: Digital	1.0	3.2	1.9	90%	4.5	5.7
EBIT: Consumer overall	9.7	19.9	11.8	22%	21.2	22.4
EBIT: Productions	(1.1)	0.4	(0.8)	-27%	0.8	1.3
EBIT: Total	8.6	20.3	11.0	28%	22.0	23.7
Overall margin	16.0%	17.4%	19.6%	22%	17.6%	17.9%
Net interest	(0.6)	(1.2)	(0.8)	33%	(1.2)	(0.9)
PBT (normalised)	8.0	19.1	10.2	28%	20.8	22.8

Source: Historic – STV, forecast – Edison Investment Research

New KPI targets introduced

To benchmark STV’s progress against strategy, management reports against a number of detailed KPIs. In these results it has shared its new targets for 2018 and provided an update on its progress against its FY16 strategic goals. We present these KPIs in Exhibit 2. Overall, the group strategy remains the same – to both outperform ITV network performance and to continue to diversify its earnings streams away from national airtime sales.

Noteworthy Financial KPI targets for 2018 include:

■

A 20% margin from consumer: this target captures the impact of continued growth in digital revenues (where it targets 55% EBIT margin – broadly the same as H116) and the board’s view that STV’s advertising revenues will be relatively resilient in a soft landing scenario for UK economy post Brexit.

■

The reinstated goal to derive 30% of earnings from non-broadcast activities: this is a fairly ambitious target and reflects management’s ongoing focus on digital initiatives where it expects growth to continue close to current rates (c 20%), as well as recent investment into its production capabilities, which is starting to deliver (albeit from a small base). To a large degree this will be affected by the performance of the UK TV national advertising market.

Exhibit 2: Summary KPIs and new targets

	2011	2012	2013	2014	2105	2016 target	Performance to target	New target: 2018
Financial targets
Group % of EBIT from non-broadcast activities	11%	11%	19%	21%	22%	NA	No target	30%
Consumer division margin	15.5%	18.3%	17.8%	17.8%	18.4%	18.0%	On track	20%
Digital revenues		£3.5m	£4.3m	£5.3m	£6.6m	£10.0m	Below but good growth	£11.4m
Digital margin		23%	30%	32%	48%	50%	On track	55%
Production revenues	£8.4m	£10.2m	£13.4m	£13.3m	£8.3m	£23.0m	Below	£20m
Production margin	6%	2%	3%	3%	5%	7%	Below	6%
Consumer operational targets
Audience to outperform ITV Network	+0.85pts	+1.3pts	+1.5pts	+0.3pts	+0.2pts	To exceed network	On track	To exceed network
Consumer reach (monthly average)	Target user numbers for TV, STV Player, City TV, City Apps, website						On track	Extended
Consumer engagement (mins/day/user)	Target user times spent on TV, STV Player, City TV, City Apps, website						On track	Extended
Long form video streams in year (m)	3.9	5.0	11.0	14.0	16.0	21.0	On track	Discontinued as a target
Consumer insights records (m)	0.3	0.5	0.6	1.0	1.6	2.4	On track	2.6

Source: STV

In robust condition – margins less exposed

The shares trade on a P/E of 8.7x FY16 and 8.0x FY17. Although some element of discount versus European peers may be expected given the uncertainty Brexit brings, it trades on a 30% FY16 and FY17 P/E discount to its closes UK peer, ITV. Historically STV’s smaller share of income from non-broadcast activities has been held as the reason for a discount to peers. However, with this figure edging up each year and the margin protection STV enjoys as a result of its relationship with ITV, at this point in the cycle such a pronounced discount seems overdone. We note the following differentiators:

Strong balance sheet: while the cloud of a weakening UK economy weighs over all advertising exposed companies, the outlook into Q3 holds no major surprises and with a relatively strong balance sheet and highly cash-generative core channel, the group is in robust condition to face any weakness in the UK economy. We forecast year-end net debt of £24m, which would equate to an EBITDA gearing ratio of approximately 1x.

Margins less exposed than typical for a commercial broadcaster. advertising visibility into 2017 is low and while the risk to our advertising forecast is on the downside, we make no change to our assumptions. It is also important to note that unlike most other television broadcasters, the impact of a shock to advertising revenues (in either direction) at STV is mitigated by its arrangement with ITV (the network affiliate arrangement, NAA), whereby STV pays a set fee for the network schedule, linked to national airtime sales, effectively locking in margin and smoothing cash flows (the fee is paid on a monthly basis). In addition STV has the scope to support margins as it moves to re-negotiate its national airtime sales contract with ITV, which expires at the end of 2016. STV has a legal entitlement to at least similar terms as the ones it receives currently, so there is no downside to exploring its options.

Continues to steadily expand non-broadcast activities: the new KPIs demonstrate management’s confidence in its strategy to continue to diversify beyond the STV channel. STV;s TV production initiatives has required some patience, however, this year revenues should recover to 2014 levels, entertainment and factual are building momentum and in the more lucrative drama market, three projects are now at the script stage. It’s approach to production investment is low risk, and adds some ‘option value’ should it succeed in developing a hit drama. In digital, the emphasis and investment is now being channelled into driving reach and engagement and in monetising the high quality data that the group is amassing via the STV registration process.

Retransmission fees: The repeal of ‘Section 73’ to pave the way for potential retransmission fees from the pay TV platforms remains squarely on STV’s agenda and it believes the government remains committed. However, priorities have shifted since the Brexit vote and the timing of when this will eventually happen is less clear.

Progressive dividend policy. the current dividend yield of 3.3% and stated progressive dividend policy should provide support to the shares.

Exhibit 3: Financial summary

	£m	2013	2014	2015	2016e	2017e
Dec		IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		112.1	120.4	116.5	124.9	132.2
EBITDA		20.1	21.5	22.9	24.5	26.2
Operating Profit (before amort. and except.)		18.0	19.5	20.3	22.0	23.7
Intangible Amortisation		0.0	0.0	0.0	0.0	0.0
Exceptionals		0.0	0.0	(8.8)	0.0	0.0
Pension finance credit/cost		(0.9)	0.0	(0.5)	0.0	0.0
Operating Profit		17.1	19.5	11.0	22.0	23.7
Net Interest		(2.8)	(2.2)	(1.2)	(1.2)	(0.9)
Profit Before Tax (norm)		15.2	17.3	19.1	20.8	22.8
Profit Before Tax (FRS 3)		14.3	17.3	9.8	20.8	22.8
Tax		(2.1)	(2.6)	1.6	(4.2)	(4.6)
Profit After Tax (norm)		13.0	14.7	15.3	16.7	18.2
Profit After Tax (FRS 3)		12.2	14.7	11.4	16.7	18.2

Average Number of Shares Outstanding (m)		39.1	39.1	39.4	39.6	39.8
EPS - normalised fully diluted (p)		33.2	37.6	38.8	42.1	45.9
EPS - (IFRS) (p)		31.6	38.7	29.8	43.3	47.2
Dividend per share (p)		2.0	8.0	10.0	12.0	14.0

EBITDA Margin (%)		17.9	17.9	19.7	19.6	19.8
Operating Margin (before GW and except.) (%)		16.1	16.2	17.4	17.6	17.9

BALANCE SHEET
Non-Current Assets		22.6	26.9	22.4	22.5	22.7
Intangible Assets		8.6	9.5	4.5	4.4	4.3
Tangible Assets		6.7	8.8	7.6	7.8	8.1
Other including deferred tax		7.3	8.6	10.3	10.3	10.3
Current Assets		47.8	61.2	55.0	53.0	54.0
Stocks		17.6	18.3	19.2	19.2	19.2
Debtors		21.4	23.1	22.1	23.8	24.8
Cash		8.8	19.8	13.7	10.0	10.0
Other		0.0	0.0	0.0	0.0	0.0
Current Liabilities		(62.0)	(19.7)	(18.7)	(18.7)	(18.7)
Creditors		(17.5)	(19.7)	(18.7)	(18.7)	(18.7)
Short term borrowings		(44.5)	0.0	0.0	0.0	0.0
Long Term Liabilities		(0.8)	(64.9)	(47.8)	(42.7)	(36.8)
Long term borrowings		0.0	(49.2)	(39.4)	(34.3)	(28.4)
Retirement benefit obligation		0.0	(14.9)	(7.8)	(7.8)	(7.8)
Other long term liabilities		(0.8)	(0.8)	(0.6)	(0.6)	(0.6)
Net Assets		7.6	3.5	10.9	14.1	21.2

CASH FLOW
Operating Cash Flow		18.3	20.9	20.0	19.8	25.2
Net Interest		(2.5)	(1.8)	(1.2)	(1.2)	(0.9)
Tax		0.0	0.0	0.0	(2.6)	(3.0)
Capex		(1.4)	(5.0)	(2.3)	(2.6)	(2.7)
Acquisitions/disposals		(0.3)	(0.3)	(0.5)	0.0	0.0
Financing		0.0	0.0	(0.9)	0.0	0.0
Dividends		0.0	(1.6)	(3.4)	(4.2)	(4.9)
Pension deficit funding		(4.2)	(5.5)	(7.8)	(7.8)	(7.8)
Net Cash Flow		9.9	6.7	3.9	1.4	5.9
Opening net debt/(cash)		45.3	35.7	29.4	25.7	24.3
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0
Other		(0.3)	(0.4)	(0.2)	0.0	(0.0)
Closing net debt/(cash)		35.7	29.4	25.7	24.3	18.4

Source: STV, Edison Investment Research

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