Southern Cross Media Group (SXL) is one of Morningstar's most undervalued companies on the ASX. We sat down with Morningstar director of equity research Brian Han for a deep dive on the company, and whether it can turn things around.

 

Why was Southern Cross' fair value estimate slashed by more than 40%?

Brian Han: It was mostly a cost issue. So, after the pandemic, the height of the pandemic, Southern Cross' revenue was recovering quite nicely, in fact, albeit very gradually. But the translation of those revenue growth into earnings growth was very erratic and very frustrating to say the least. So, now, we have an environment, a revenue environment, that is now slowing. And then, we just came to the realisation that perhaps Southern Cross' underlying inherent earnings power is not as high as we thought it would be because of these cost issues. And that was the reason why we slashed our valuation on the stock.

Why do you think SXL might be a value trap?

A value stock is a stock that looks cheap across all valuation metrics, whether it's P/E, EV to EBITDA, or dividend yields. However, it stays cheap for a lot of reasons. And two of them is basically operational performance and earnings delivery and the erratic nature of those metrics. So, that's the first thing. And it could be a cyclical issue because at certain points in the investment cycle, investors don't like to invest in certain sectors of the market. It could be a structural issue, or it could be a management issue.

Now, in Southern Cross' case, it could be a combination of all those issues because the stock has been cheap for a number of years. Unfortunately, their earnings delivery and their operational performance, they have been quite erratic and sometimes quite disappointing. And so, therein lies the fact that perhaps some people will see Southern Cross as a value trap.

Do you think the stock has been oversold?

Yes, I do. And I say that because on valuation screens, it is screening quite cheaply. It's trading at 12 times P/E, it's trading at about 3.5 times EV/EBITDA, and it's yielding about 10%. Now, even if I take a knife to my dividend forecast, it is still yielding about 6% fully franked. So, on that basis, it is cheap. Now, on top of that, if you look at some of the structural or qualitative stuff, it has a good balance sheet, in fact, so much so that it has just bought back a bunch of its shares and the balance sheet still looks quite solid. And then, that radio advertising market, I know there's a lot of digital disruption and all that, but relatively speaking, compared to other main media, traditional media, it is quite a resilient sector and Southern Cross generates over 80% of its earnings from that radio sector. So, when you put all of those up and the fact that management is now hopefully going to focus more on costs, we do feel that at current valuations, the market is being too pessimistic on the stock.

What company priorities need addressing for a share recovery?

Firstly, I think management needs to bring a laser-like focus on operating costs. In my opinion, since the pandemic, I think all the hard work management put in, in terms of improving cost efficiency and cost cuts, I think they have been mostly undone in recent couple of years. And that's unfortunate. And it might be because company over-hired, like many companies did, since the heart of the pandemic, or it could be they're investing too much into the whole digital streaming and audio area. Whatever it is, I think the company should refocus on their operating costs and make sure that their margins are comparable to some of its peers.

And then, the second area they should focus on is bring more accountability to the investments that they're making in digital audio and streaming space. Now, I understand strategically they need to stake their ground in that space and make sure that they capture their audience wherever they go, whether it's in traditional radio or digital streaming or digital audio. But that's one thing. It's another thing to keep on spending without having a view as to the return of those investments, whether in the near term or in the long term. So, if they can focus on those two fronts, hopefully the stock price will follow what this company should intrinsically be worth.