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Juenger Downgrades Discovery

Influential Sanford Bernstein media analyst Todd Juenger lowered his rating on Discovery Communications from “market perform” to “underperform” and changed his entire valuation methodology for the cable network content sector, focusing more on cash flow and debt than earnings.

Juenger has been one of the staunchest critics of the current pay TV content model and said in his report he remains “decidedly negative” on television network stocks for long-term structural reasons like “over-earning” and near term reasons like summertime cord cutting.

“Investors are asking ‘are media stocks cheap enough to own?’ We say ‘no,’ because the balance sheets are still levered as if growth will persist and the future is certain,” Juenger wrote in a note to clients.

Juenger also moved away from common valuation methods for the stocks, like price/earnings (P/E) ratios, and instead will now value shares on an enterprise value to cash flow (EV/EBITDA) basis. The latter, he wrote, is a much better predictor of future performance.

But the new methodology also claimed its first victim – Discovery. In his note, Juenger said the stock trades at low double-digit P/E, but it trades at 11 times EV/EBITDA, which he claims is too high. And instead of reducing leverage, Discovery is adding more debt, he wrote.

Juenger wrote that Discovery has suffered as it has strayed from its brand, creating openings for networks like NatGeo to take up the slack. International revnue growth is decleerating quickly and Juenger belieeves that with 14 networks, Discovery is just too bulky for today's "skinny bundle" universe.

“There are positives and negatives about [Discovery’s] competitive positioning, but as we run through the pros/cons, in the end it wasn't even a close call,” Juenger wrote. “With operating and TV assumptions we feel are more likely generous than punitive, we come to a target price of $23 [per share].”

Discovery shares closed Monday at $28.88 each (up 49 cents or 1.7%). The stock was down 48 cents each, or 1.7%, in early after-hours trading June 6 to $28.40 per share.

Juenger retained his “market perform” rating on CBS and Scripps Networks, adding that while the stocks were “on the bubble,” his target prices for both were about even with their current trading levels.

“If we were making a 2H16 trading call, it would likely be Underperform,” Juenger wrote. “But we are making a 12-month recommendation, and believe CBS and [Scripps Networks] are relative winners among media stocks in the long run, so we retain our Market-perform ratings.”

21st Century Fox was the lone TV stock under his coverage that kept its “outperform” rating, mainly because it holds up better under EV/EBITDA than P/E.