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Corus Entertainment Inc


Positive Review

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Stock Review

Corus Entertainment (CJR) is one of Canada's largest media and entertainment companies. Generally speaking, Corus operates two business segments. Radio (about 20% of operating profit) consists of 53 radio stations across Canada, covering a variety of music genres and station formats, making it the second largest radio operator in the country after Astral Media with about a 28% market share. The second segment is Television (80% of operating profits), which can be further broken down into specialty and premium television networks (channels) and content creation. On the channel side, Corus completely or partially owns some well-known networks such as TELETOON, YTV, W Network, Movie Central, and Encore Avenue. Corus also owns a handful of broadcast TV stations. On the content side, the most valuable subsidiary is Nelvana, which is responsible for some well-known children's properties that are distributed over kids' networks such as Nickelodeon and Disney Channel. Parents of preschoolers no doubt recognize some of Nelvana's roster, which includes The Backyardigans, Franklin, and Babar, among others. These content assets also allow Corus to run some small merchandising and publishing operations that are based upon them (like toys, clothing, books, etc.).

Historically, media businesses were great investments. There is only a limited band of broadcast frequencies, and in the past owning some of these represented a long-term competitive advantage. These advantages are all but gone in the current digital era. Terrestrial free radio has been a dying business, particularly with the advent of iPods and satellite radio. The same can be said of network television, which faces even more competition from cable, satellite, video-on-demand, DVDs (and now Blu-Ray), and the Internet. Also, since both of these business models rely primarily on advertising for revenues, they were subject to big sales losses during recessions, as advertising dollars are often the first place businesses in stress cut back spending. This part of Corus is not very attractive going forward.

On the other hand, both premium cable channels and content creation are excellent businesses even today. Cable and satellite has virtually saturated the North American market with its better reception, more channels, on-demand content, and now, high definition offerings. Specialty cable channels like Corus' YTV or W Network earn revenues both from carrier subscription fees (such as Comcast CMCSK) and advertisers - a dual channel of dollars less susceptible to cyclical ad spending patterns. Content is an even better business. Corus' focus is on children's content, which, as anyone with preschoolers knows, can be recycled over, and over, and over (and over) again to both the same and newer generations of little ones. Character content can also be leveraged across multiple sources of new media and even merchandising. And content licensing is a low-capital, high-margin business. MagicDiligence really likes Corus' TV and content operations. They are well positioned in two demographics that advertisers love (children and women), and in niches that afford some durability to competitive advantage.

Financially, Corus has good and bad points. On the good side, margins are outstanding even for media, with operating margin averaging 27% over the past 5 years and in fact strengthening over that time period. Magic Formula return on capital is strong at 48%, and free cash flow margin is consistently in the 12-15% range, which is very good. On the bad side, the balance sheet is less-than-stellar, with a $680 million debt load offset by only $32 million in cash. When you consider also that this company generates about $100 million in free cash flow a year, the debt load is on the heavy side. Interest coverage ratio further backs up this point, with operating earnings covering debt interest just 5.6 times, the very low end of MagicDiligence's absolute minimum of 5 times.

Growth will come mainly from acquisition. Corus has historically grown through this manner, steadily building up controlling interests in most of their premium channels and radio stations. Additional opportunities to acquire children's or women's content studios would be ideal. As with any acquisitive company, though, we have to be sure that management is not overpaying. There is some indication that Corus has paid too much for growth. Standard return on capital has averaged only about 10% when goodwill is included, and Corus just took a $175 million impairment charge on goodwill. This will continue to be a risk going forward.

In conclusion, Corus is another good, but not great, Magic Formula stock. Its premium TV channels and children's content businesses are good ones, but the radio station business is less so. The company should remain a high margin cash creator, and with a nice 4.3% dividend yield makes a nice choice for those who are looking for some income returns. However, growth will be expensive and the debt burden is such that Corus will probably not be making any significant new purchases in the near future. At a 13% earnings yield, there is enough valuation and dividend yield potential here for nice returns, but I'll look elsewhere for the next MagicDiligence Top Buy.

Steve does not own CJR.

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