Comcast (CMCSA): High Marks for Dividend Safety and Growth, But What About the Cord-Cutters?

At first glance, Comcast Corporation (NASDAQ:CMCSA) looks like an investment every dividend investor should consider.

The company has increased the dividend every year since reinitiating it in 2008, recorded nearly 23% annual dividend growth over the last five years, maintained a relatively low payout ratio, and enjoyed stability from its recession-resistant businesses.

These are some of the characteristics we look for in our search for safe dividend stocks (see all five of our tips on how to find safer stocks here). Comcast shares many attributes with the investments in our Top 20 Dividend Stock portfolio (1).

However, with cord cutting gaining more and more traction, is Comcast’s future as bright as its past?

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Business Description

Comcast Corporation (NASDAQ:CMCSA) is a global media company with two main businesses, Comcast Cable and NBCUniversal.

The Cable Services business (62% of revenue) is one of the nation’s largest providers of video (29% of total revenue), high-speed internet (17%), and voice services (5%) to residential customers under the XFINITY brand. Other operations, such as business services and advertising, account for another 12% of total sales.

The NBCUniversal group (38% of revenue) is made up of four main businesses: Cable Networks, Broadcast Television, Filmed Entertainment, and Theme Parks businesses.

The Cable Networks business (13% of total revenue) consists of their national cable networks, regional sports and news networks, international networks, and cable television studio production operations. Examples of their networks include USA Network, E!, Syfy, MSNBC, CNBC, Bravo, NBC Sports, Oxygen, and the Golf Channel.

The Broadcast Television business (11% of revenue) consists of the NBC and Telemundo broadcast networks, local NBC and Telemundo broadcast television stations, and broadcast television studio production operations. They own NBC-affiliates and Telemundo stations in major U.S. cities including New York City, Los Angeles, Chicago, Philadelphia, Dallas-Fort Worth, San Francisco-Oakland-San Jose, and Miami.

The Filmed Entertainment business (10% of revenue) consists of the operations of Universal Pictures, which produces, acquires, markets and distributes films all across the world.

Finally, the Theme Parks business (4% of revenue) consists of the Universal theme parks in Orlando, Florida, and Hollywood, California, along with majority ownership of Universal Studios theme park in Japan.

Business Analysis

Since the Cable Services business is the largest segment and is arguably the most controversial due to cord cutting, we need to dig further into this business.

Comcast was founded in 1963 by Ralph Roberts as a single-system cable operator in Tupelo, Mississippi, with the purchase of American Cable Systems, a 1,200 subscriber cable system.

Over its history, one of the main ways the company grew was from acquiring many large and small cable operators to build out its footprint in major metropolitan areas.

Some of the larger media investments over the years include Group W Cable, Storer Communications, Maclean Hunter, E. W. Scripps, Jones Intercable, Prime Communications, Lenfest Communications, AT&T Broadband merger, and NBCUniversal, along with a whole host of other transactions.

More recently Comcast attempted to merge with Time Warner Cable, but the transaction was terminated after large opposition from industry groups, the general public, and antitrust authorities.

All of this merger and acquisition activity over decades has made Comcast into the largest cable company in the United States. Their coverage extends over many major metropolitan areas including Philadelphia, Washington, DC, Pittsburgh, Chicago, Indianapolis, Denver, SanFrancisco, Portland, and Seattle.

All in all, they pass nearly 56 million homes and businesses and have nearly 28 million total customer relationships. They have 22.3 million video customers (cable TV), 23.3 million high speed internet customers, and 11.5 million voice customers (telephone).

The company’s costly network infrastructure, convenient bundled services, vertical integration, and sizeable subscriber base serve as key competitive advantages.

A small number of players dominate the industry, and barriers to entry are high because of the major investments required for technology infrastructure, programming content, and customer acquisition.

Without a large subscriber base, these costs cannot be covered. The mature state of the industry makes it especially difficult for new entrants to acquire customers.

The main concerns of many investors and industry participants is how declining cable subscribers from cord cutting and declining voice subscribers will affect the business.

It is hard to argue with some of these arguments as Netflix, Inc. (NASDAQ:NFLX), Hulu, and other “Over-the-Top” platforms continue to add subscribers, but let’s take a look at the actual numbers.

While total video customers are down in recent years, so far cord cutting hasn’t had a huge impact on their subscriber numbers. Customers are down a little over 1% from 2013 levels, or from 22.6 million to 22.3 million. Furthermore, the 36,000 video customers lost in 2015 was the company’s best result in nine years.

Despite the slight decline in the number of customers, video revenue was up nearly 5% from 2013 to 2015.

Video revenues rose as a result of more customers receiving additional services (HD or DVR advanced services) and increasing pricing. 13.9 million of their subscribers now receive at least one of their HD or DVR advanced services, up from 13 million in 2014 and 12.5 million in 2013.

As seen below, rising revenue per customer relationship has helped drive cable revenue higher over the last couple of years.

Source: Comcast Investor Presentation

Throughout the first six months of 2016, they have actually been able to hold Video customers relatively flat compared to year end 2015. Furthermore, they have been able to grow revenue by 3.3% year-over-year during this timeframe.

While cord cutting is certainly a risk that needs to be monitored, for now it has not proliferated throughout the subscriber base. Also, Comcast can retain many of these marginal customers by offering a “skinny bundle,” or just a small subset of channels that desired most by certain subscribers.

Even though Comcast is very unlikely to grow video subscribers, they should be able to retain the vast majority of their base and be able to grow revenue through pricing and adding on additional services.

Total voice customers were up around 7.5% from 2013-2015 (from 10.7 million to 11.5 million) while revenue was down around 2% during this timeframe.

The main reason voice revenue declined despite the increase in customers is because it was negatively impacted by the allocation of voice revenue for their customers who received bundled services. The amount Comcast allocated to voice within the bundled service decreased while the amount allocated to video and high-speed internet rates increased.

So far year-to-date in 2016 these same trends have continued. Voice customers are up slightly from year-end 2015 to 11.6 million and up about 3% year-over-year, while revenue is down by about 1%.

With the proliferation of cell phones, it is probably safe to say that if voice was not included as a bundled service, the total number of customers would likely be declining. This is not a major driver of Comcast’s economics and we are comfortable with the current strategy of bundling the service.

On the topic of voice, it’s also worth pointing out that Comcast plans on offering its own wireless service (2) by mid-2017. This action could potentially help Comcast’s bundling proposition and further raise switching costs for its subscribers.

Despite cord-cutting, Comcast appears likely to remain a dominant force in the media industry for years to come.

Dividend Safety Analysis: Comcast

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Comcast’s dividend and fundamental data charts can all be seen by clicking here.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.

Comcast Corporation (NASDAQ:CMCSA)’s Dividend Safety Score is 98, which indicates that the dividend is extremely safe and one of the safest in the entire market. The key drivers of this phenomenal safety score are a relatively low payout ratio, consistent free cash flow generation, a stable economic profile, and a healthy balance sheet.

Currently, analysts expect Comcast to generate diluted earnings per share (EPS) of $3.51 for Fiscal Year 2016, and we expect the company to pay out about $1.10 per share in dividends. This implies a payout ratio of about 31%, which is roughly in line with historical levels since the dividend was reinstated in 2008.

Over its history, Comcast has been a great cash flow generator with positive free cash flow every single year over the last decade. This is despite a relatively capital-intensive business model. Comcast spent about $8.5 billion in 2015 on capital expenditures, which is up from $6.6 billion spent in 2013.

Comcast is investing in line extensions and in scalable infrastructure to increase network capacity. They believe that investments in the network help them stay ahead of increasing bandwidth consumption by customers. These investments can be monetized through increasing subscriber growth and increasing pricing due to better service and faster speeds.

Over the last three years, Comcast has generated between $7.5 billion and $10 billion per year in free cash flow while paying out around $2.5 billion in dividends per year. This implies a fairly conservative free cash flow payout ratio.

Over the last decade, Comcast has sustained a very stable economic profile. Operating margins have consistently been in the high teens to low 20% range, and sales growth has been positive every single year. Sales and earnings grew throughout the financial crisis as well, and Comcast’s stock outperformed the S&P 500 by more than 30% in 2008. Few companies can boast this type of stability that we love to see as dividend investors.

Comcast has a relatively healthy balance sheet for their business model as well. They have $4.7 billion dollars in cash and $55.5 billion dollars in gross debt. This implies a net debt/EBIT ratio of 3.2x.

While for some cyclical business this would be on the higher end of what we typically like to see, Comcast has a very stable, more recurring revenue based business model that produces predictable cash flow, which can support leverage on the balance sheet.

This assertion is backed up by Moody’s investment grade A3 senior unsecured rating on Comcast’s debt.

Comcast has the debt laddered nicely with $33.8 billion of the $55.5 billion in debt due after 2020, so there shouldn’t be any near term liquidity issues at the company.

Overall, Comcast’s dividend is extremely secure and investors should be able to count on safely collecting the 1.7% yield.

Dividend Growth Analysis

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

Comcast’s Dividend Growth Score is 95, which indicates that the dividend has extremely good growth potential.

Comcast initiated their quarterly dividend in 2008 at 6.25 cents per share and has grown it every year since. The latest increase occurred near the beginning of 2016 when management raised the quarterly dividend by 12% to 28 cents per share.

Over the last five years, the dividend has grown at nearly a 23% CAGR (compound annual growth rate). Dividend growth has remained strong over the last three years as well, compounding by approximately 15% annually.

While we don’t expect the dividend to increase at a 20%+ rate going forward, we do expect the dividend to increase at a minimum mid- to high-single digit clip. The drivers of this are the relatively low payout ratio and solid earnings growth.

We believe that the company could increase the dividend at a faster pace, but management is focused on a balanced shareholder return plan which includes share repurchases.

Management has elected to repurchase billions of dollars of stock over the last few years, including $6.75 billion dollars in 2015 and $2.4 billion through the first six months in 2016.

Overall, investors should expect dividend growth of at least mid- to high-single digits with additional upside depending on how management decides to allocate the excess cash the company generates.

Valuation

Comcast currently trades around 19x 2016 earnings estimates and offers a dividend yield of 1.7%, which is in line with its five-year average dividend yield.

Comcast’s business model is pretty stable given the significant portion of revenue generated from predictable subscriptions and advertising. While there are risks to the business, the industry is likely to change slowly.

More importantly, Comcast will have a front row view of how the industry is likely to evolve and management can position the company to capitalize on new opportunities.

Overall, Comcast looks like it can drive mid- to high-single digit EPS growth or more if they continue to buy back stock. If this were to happen, investors look poised to generate a decent mid- to high-single digit annual total return from owning the stock at these levels.

Conclusion

Comcast is one of the largest media companies in the world with businesses spanning from cable distribution to content creation.

While Comcast doesn’t quite have the dividend longevity to be considered a blue-chip dividend stock (see some of our favorite blue chip stocks here), it has grown the dividend every year since reinitiating it in 2008 and has a solid five-year annual dividend growth rate over 20%.

While the current yield of around 1.7% doesn’t look very attractive for someone living off of dividends (3), the dividend should continue to grow at a nice pace due to the stability of the business model, Comcast’s low payout ratio, and a handful of earnings growth opportunities.

The business is not trading cheaply at 19x 2016 earnings forecasts, but investors should know that the dividend is safe and earnings should continue to grow, which could result in a reasonable total return over time.

Additional Links

(1) http://www.simplysafedividends.com/top-dividend-stocks/

(2) http://www.usatoday.com/story/tech/news/2016/09/20/comcast-wireless-service-due-next-year/90727694/

(3) http://www.simplysafedividends.com/living-off-dividends-retirement/