Idea List: Issue #14
This week I analyze ST Microelectronics and Gray Television
In this post I want to share two stock ideas that appear to be undervalued. These companies came from the “top of the funnel” of my research process, meaning they came from stock screeners, or recommendations from Twitter and Substack. What I want to do here is present some qualitative and quantitative metrics that determine if I should keep researching the stock or take a pass on it. Further, I want to do a basic valuation to verify that the company is actually undervalued. The end goal is to have some semi-vetted stock ideas that I can add to a watchlist and start doing more thorough research on.
ST Microelectronics
ST Microelectronics STM 0.00%↑ is a Swiss based semiconductor company with a market cap of $24B. They make microcontrollers and many other types of chips used in automotive, industrial, and consumer electronics. Earlier this year the stock was trading north of $45 but has fallen to around $25. STM was a favored stock because a good chunk of its revenues comes from automotive and is poised to benefit from electric cars. I decided to look at this stock because I’m an electrical engineer with a background in semiconductors (oddly enough I rarely look at semiconductor stocks), the fact the stock has sold off, and because it is trading at a TTM price to earnings of 10.7x.
STMs 10 year revenue growth has averaged 8.5%, but lot of that is probably from the last few years. After COVID, there were shortages of semiconductors which caused a surge in revenue and profits. Now there is a glut of semiconductor inventories which has caused ST’s sales drop by over 20% this year. From a glance its hard to say what a normal revenue growth rate is for ST since it was only mildly growing until the past few years, and now there is a cyclical downturn.
Every year since 2017 STM has had pretty good return on assets, often times over 10%. Even though STM often earns more than its cost of capital, I’m not sure I would say it has a competitive advantage. From my high level analysis they seem to produce more generic, commodity-like chips instead of cutting edge specialized chips like GPUs. These types of semiconductor companies historically have been cyclical, and the revenue declines support that. That being said, STM seems to be a good business.
Like I mentioned, ST Microelectronics is trading around 10x earnings. Their trailing twelve month earnings per share is $2.43. Breaking this down, we see that over the last 9 months the company has made $1.29 a share, meaning they earned $1.14 in Q4 2023. The fact that STM almost made more last Q4 than all of this year means the trailing P/E ratio is not very helpful. I think it makes more sense to look at what management is guiding for Q4 2024 to figure out a more realistic earnings ratio for STM.
Looking at ST’s latest quarterly results show that 9 month revenue was $9.95B, and the management is guiding for $3.3B in Q4. The management is also guiding for 38% gross margin, which is decently below recent margin levels. Operating expenses look to be pretty consistent, so I will estimate them at $850M. Based on these estimates, Q4 net income might come in at $340M, or $0.36 a share. Adding this to the EPS they already generated this year we get $1.65 in earnings per share for the full year. This implies that STM is really trading at a forward multiple of 15.3. This earnings multiple for STM is modestly below the normal range of 20, but it suggests STM is not super undervalued. For now I’ll say that I would be more interested if the stock sold for 10x forward earnings, so I would give STM a hold rating at this price.
Gray Television
Gray Television GTN 0.00%↑ caught my eye because it is trading at a price to book value of 0.25. The company owns and operates broadcast TV stations, which is considered a dying business. TV stations (and radio stations like Urban One that I wrote about) get a surge in revenue during election years. Gray Television is currently trading with a market cap of $500M. GTNs stock price was already on a downward trend, but sold off more after their recent earnings where revenue from political ads was not as high as the management guided.
One thing that you quickly notice is that GTN has a lot of debt. The company has $5.9B in long term debt vs $2.7B in equity yielding a debt to equity ratio of 2.2. TTM EBITDA is $1.06B, so debt to EBITDA is over 5.5 which is leverage buyout levels of high. TV stations historically were steady sources of cash, which means it was reasonable to have a lot of debt. Now that they are a declining industry, the debt load worries me.
It appears the increase in debt comes from a $2.6B acquisition in 2019 and a $3.3B purchase in 2021. These acquisitions have placed $2.6B on goodwill on GTNs balance sheet. When I value companies based on their assets, I will zero out the goodwill but look at the other tangible and intangible assets to see what their replacement cost is. While I did not figure out the replacement costs for Gray’s assets, a disappointing realization was that the company has $2.8B in equity. That means almost all of the equity is from the goodwill. If you zero out the goodwill, GTN would be trading at like 2.5 times book value instead of 0.25. Figuring out the replacement value of the assets might give it a slight improvement but probably not enough end up with a net asset value significantly higher than its current market cap.
Looking at GTNs income statement is tricky since they made two large acquisitions. The last two years are all you can look at to get an idea of GTNs sales and profits in its current form. Revenue peaked in 2022, and it also produced nearly $1B in operating income. However that year had midterm elections so there was some boost in political ad spending. The following year saw a dip in revenue and operating income came in at $450M. The problem is that over the last several years, interest expense has increased to a TTM value of $480M. So it looks like with its current debt load and where interest rates are, on off-election years GTN will barely be able to pay its interest. From reading other write ups on GTN, the managements strategy is to use the excess cash produced during election years to pay down debt to a reasonable level, a process that will take a few years.
I think with TV stations being melting ice cubes, and Gray’s strategy of banking on political ad spending (which came in below expectations this year) puts the company in a precarious situation. Perhaps I would be interested in Gray if they reduced their debt load and I had more confidence in their operating earnings. For now, I think the low price to book ratio is misleading and that the company is not undervalued, so its a pass. However, if you feel like gambling, you could make the argument that Trump’s administration could allow consolidation in this industry so maybe someone will buyout Gray.