Join our community of smart investors

Tune into Entertainment One's growth

Entertainment One's lowly-rated shares belie the group's stellar prospects in film and television
July 16, 2015

Great films are often snubbed at the Oscars. Similarly, we feel investors aren't giving Entertainment One (ETO) the credit it deserves. The group, which licenses out distribution rights for films and television shows to more than 500 broadcasters worldwide, is supplementing strong TV sales with international acquisitions and higher-margin production. Meanwhile, its film division looks poised to benefit from a strong slate of cinema releases this year. Yet, despite the company's growth prospects, its shares trade at just 11 times forecast earnings for the year to March 2017.

IC TIP: Buy at 327p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points
  • Global reach and vast content library
  • Peppa Pig's prolific rise
  • Strong sales and profit growth
  • The shares are cheaply rated
Bear points
  • Investments weighing on cash flows
  • Volatile box office revenue

Entertainment One's main growth engine is its TV business. The division's underlying sales leapt nearly a third last year, driving adjusted cash profit up 41 per cent to over £51m. It benefited from a 27 per cent rise in production and sales revenue, as shows such as Rookie Blue and Saving Hope attracted droves of viewers. But the real star was the TV division's smaller 'family' segment, which licenses out broadcasting and merchandising rights to branded properties. Sales soared 71 per cent and cash profit more than doubled, to about £24m, as pre-school brand Peppa Pig generated over $1bn (£640m) in retail sales worldwide and secured more than 600 licensing deals. The animated piglet has also won space on the shelves of US retail giants Walmart and Target, and management is rolling out the character in Brazil, China and elsewhere.

Growth is coming from acquisitions, too. Entertainment One bought reality-TV producers Force Four and Paperny last year. It also took a majority stake in Grey's Anatomy producer The Mark Gordon Company. That marked its first direct step into the enormous US market, bolstered its higher-margin production business and strengthened its ties to Hollywood. The studio already has two new shows in the works: Quantico for ABC and Criminal Minds: Beyond Borders for CBS. Management expects the deal to help it increase TV programming output by around half to over 850 half hours.

Television production can be hit or miss, but Entertainment One minimises its risk by only approving shows that have 85 per cent of their production costs covered by tax credits, broadcaster pre-sales and the Canada Media Fund - a not-for-profit organisation. It also has a large content library to fall back on, which was independently valued at $801m in March 2014 and contains more than 40,000 films and TV shows, 4,500 hours of television programming and over 45,000 music tracks. At the risk of alienating partners such as Netflix and Amazon Instant Video, we believe it could realise some of that value by launching its own streaming service.

Entertainment One's film division offers recovery potential after suffering last year from a weak global box office, fewer theatrical releases and lower home entertainment sales, as consumers ditched DVDs in favour of streaming services such as Netflix. Management expects to benefit from a stronger film slate this year, new distribution deals with digital partners such as Amazon and an increase in film releases from 227 to about 250. Broker Numis expects film revenues to rebound by 14 per cent to £674m and the division's margins should continue to widen as broadcast and digital sales overtake home entertainment revenues.

Numis forecasts annual sales growth of at least 15 per cent in the main TV subdivisions - production and family - over the next three years. Yet shares in Entertainment One trade at just 13 times full-year forecast earnings, falling to 11 times in the following year, which we think is an unjustified discount to film and TV peers.

Critics may point to Entertainment One's sizeable debt pile. Strip out £89m of short-term production financing and underlying net debt more than doubled to £225m last year. Moreover, management continues to invest heavily in content and acquisitions, which is likely to curtail near-term cash generation.

ENTERTAINMENT ONE (ETO)
ORD PRICE:327pMARKET VALUE:£1.0bn
TOUCH:356-357p12-MONTH HIGH:374pLOW: 266p
FORWARD DIVIDEND YIELD:0.4%FORWARD PE RATIO:11
NET ASSET VALUE:123p*NET DEBT:86%

Year to 31 MarTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20130.635415.9nil
20140.827821.01.0
20150.798923.51.1
2016**0.9510224.81.2
2017**1.0411929.11.3
% change+9+17+17+8

Normal market size: 3,000

Matched bargain trading

Beta: 0.7

*Includes intangible assets of £297m, or 101p a share

**Numis forecasts, adjusted PTP and EPS figures