Danger Zone: Comcast (CMCSA)

Check out this week’s Danger Zone Interview with Chuck Jaffe of Money Life and MarketWatch.com.

Comcast (CMCSA: ~$51/share) is in the Danger Zone this week. The cable giant’s reign of power and profit growth is coming to an end. The stock is priced as if the good-ole days will continue and profits will continue to grow at a higher rate than I believe possible. The proposed merger with Time Warner Cable (TWC) is nothing more than a last ditch effort to consolidate market share and will hurt, rather than help, shareholders.

Economic Earnings Decline Is Leading Indicator

Figure 1 shows the disconnect between Comcast’s reported earnings and its economic earnings. With a bottom-quintile ROIC of just 6%, Comcast’s business is not as healthy as it may appear.

The company is in a very capital-intensive business, which means profits are very sensitive to margins. And margins are very sensitive to how the company prices its products.

When a company like Comcast loses pricing power, profits will drop quickly. It is easier to hide the loss of pricing power in accounting earnings than in economic earnings.

For example, $50 billion in total debt (40% of market cap), $32 billion in deferred tax liabilities and another $1 billion in pension underfunding help prop up EPS while real cash flows suffer.

Figure 1: Economic Earnings Lag Reported Earnings

CMCSA_EconomicEarnings

Sources:   New Constructs, LLC and company filings

The Beginning Of the End to Monopolistic Pricing Power

New online competitors like Netflix (NFLX), Hulu and Amazon (AMZN) along with offline competitors like Redbox are taking customers away from Comcast’s core cable TV business. Over the past fours years, CMCSA’s video customers have declined by 2% compounded annually.

Worse yet, CMCSA is losing its status as the only Internet provider in many areas. For a long time, that status allowed CMCSA to set monopoly-level prices on Internet services and then bundle in TV and voice to earn additional revenue. Now, Verizon (VZ) and AT&T (T) are offering internet services at very competitive prices in many areas where Comcast used to be the only game in town.

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David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

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