When Discovery (NASDAQ:DISCK) quietly rose from a year-long $20.00 to 22.50 range in 2020, few investors talked about it. Between Feb. and March, value investors could not explain Discovery stock breaking out to a high of $78.14.
Only after Archegos Capital imploding on Mar. 28 did markets fully comprehend what drove Discovery shares to unsustainable highs. The firm, a family office run by Bill Hwang, took a leveraged bet by buying both Discovery stock and ViacomCBS (NASDAQ:VIAC). After selling $20 billion worth of stocks to cover its margin call, Discovery has yet to recover.
What should investors who bought at the highs do next?
Discovery Stock in Freefall
For a brief moment of no more than a month, Discovery shares, after breaking through the 50-day and 200-day moving average, found support at $35.00. Selling resumed when investors decided to minimize further losses. At a forward price-to-earnings ratio of around 10 times, value investors may start buying from here. Yet if history repeats itself, shares may fall below the 5-year trading range of $22 – $33 a share.
Multiple block trades that sent Discovery shares lower are allegedly lower. No one knows for share. Markets may ignore the company’s fundamentals until the trading uncertainties ease. Besides, the fourth-quarter results are fine but not great.
In Q4, Discovery posted a lack of revenue growth at $2.89 billion. Despite U.S. advertising revenue flat and distribution revenue up 5%, international networks dragged on results.
The company’s launch of Discovery+ with Verizon Communications (NYSE:VZ) is a step in the right direction. Yet the streaming content market is very crowded, dominated by many players. This includes Netflix (NASDAQ:NFLX) and Disney (NYSE:DIS).
Discovery reported the total share of viewing across its international portfolio rose by 4% Y/Y. The six consecutive quarters of share growth suggests a sustained momentum ahead. It boasted over 11 million total paying direct-to-consumer subscribers globally. Management proved that its investments in Discovery+ are paying off. As it scales the service, profit margins will expand.
The ongoing Covid-19 pandemic is a positive contributor to Discovery+ growth. That is also a risk factor in the medium term. Many States in the U.S. vaccinated half of the residents. As each State achieves herd immunity, lockdowns will ease. People will go outdoors and will socialize. That includes going to the movies. The pivot away from streaming to other traditional channels is a risk factor for Discovery.
Investors may look to Wall Street to get an idea on what Discovery shares are worth. Yet only one analyst offered a price target of $43.00 on Discovery, over two months ago (per Tipranks). On simplywall.st, the site figured that based on future cash flow, the stock is worth around $80.00.
Readers may refer to a five-year discounted cash flow model (Gorden Growth Exit) model. Based on the assumptions below, the stock has a fair value of around $37.00.
|Discount Rate||10.0% – 9.0%||9.50%|
|Perpetuity Growth Rate||0.0% – 0.5%||0.00%|
|Fair Value||$33.72 – $42.55||$36.63|
Readers may raise the growth rate forecast to come up with a higher price target. Given the pressures ahead, revenue growth of around 3% – 5% annually is already an optimistic scenario.
President and Chief Executive Officer David Zaslav said, “Our unmatched global scale and ability to serve consumers everywhere with a truly differentiated offering across platforms, as well as our robust cash flows, even amidst the significant investments in our next generation initiatives.”
Unfortunately for income investors, the company is not sharing the robust cash flow through dividend payments. ViacomCBS pays a 96-cent annual dividend. This token payment will earn investor confidence in the competing firm’s potential. ViacomCBS may simultaneously grow its content, build its online streaming service offering and still reward investors with regular dividend income.
Discovery may face months of selling pressure. The stock has plenty of overhang from speculators who bought shares on the way up. Those shareholders may take any small rally to sell shares. Netflix and other streaming services firms are attractive alternative investments.
Disclosure: On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.