Digital Conversion And Transit Risks Will Likely Restrain Long Term Earnings Potential

Catalysts

About OUTFRONT Media

OUTFRONT Media is an out of home advertising company focused on billboard and transit media, including an increasing mix of digital formats.

What are the underlying business or industry changes driving this perspective?

• The push toward digital conversions, which currently provide roughly 4x uplift versus pre conversion revenue levels, could stall if capital spending of about US$85 million a year is constrained. This would cap digital revenue growth and limit any further improvement in billboard yield and overall revenue.
• The company is leaning heavily on programmatic and automated digital sales, which were up nearly 20% and now represent 16.5% of digital revenue. However, reliance on a still developing buying ecosystem and slower adoption from dedicated digital media buyers could leave digital monetization below expectations and pressure revenue and earnings.
• The reorganization into commercial and enterprise teams, along with centralized operations and a new Brand Solutions Group, introduces execution risk. Disruption to sales relationships and internal processes could offset the expected US$18 million to US$20 million in annual expense savings and limit any margin expansion at the billboard and transit level.
• The exit of two large marginally profitable billboard contracts in New York and Los Angeles removes revenue that management expects to be a headwind. If replacement demand in those key markets does not materialize at attractive terms, billboard revenue and billboard adjusted OIBDA could remain under pressure despite portfolio pruning.
• Transit growth is currently tied to digital formats and key franchises such as the New York MTA. Exposure to fixed franchise payments, MAG escalators and rising maintenance and utilities costs means that any slowdown in digital transit demand or ridership recovery could compress transit adjusted OIBDA margins and limit overall earnings growth.

Assumptions

This narrative explores a more pessimistic perspective on OUTFRONT Media compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming OUTFRONT Media's revenue will grow by 3.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.4% today to 11.3% in 3 years time.
• The bearish analysts expect earnings to reach $228.0 million (and earnings per share of $1.28) by about January 2029, up from $115.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 18.2x on those 2029 earnings, down from 34.4x today. This future PE is lower than the current PE for the US Specialized REITs industry at 27.3x.
• The bearish analysts expect the number of shares outstanding to grow by 0.13% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.12%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company is putting significant effort behind digitization, with digital billboards seeing around a 4x uplift in revenue compared to pre conversion levels and digital transit revenue growing 17% in the quarter, so if this shift continues to gain traction it could support higher revenue and OIBDA than a bearish view implies.
• Programmatic and automated digital sales were up nearly 20% and now account for 16.5% of digital revenue, and if the large pool of dedicated digital media buyers that currently underuse digital out of home starts allocating more budgets to this format, that could underpin stronger long term revenue and earnings.
• Transit revenue grew 5.6% in the quarter, helped by digital formats and a healthier New York MTA franchise, and if ridership trends and advertiser demand in transit stay firm or improve, transit adjusted OIBDA and consolidated margins could be more resilient than expected.
• The restructuring that removed around 120 roles is expected to deliver US$18 million to US$20 million of annual expense savings, and if the new commercial and enterprise sales structures, Brand Solutions Group and centralized operations bed down successfully, SG&A and operating costs could trend lower as a share of revenue, supporting net margins and AFFO.
• Management is focused on pruning lower margin billboard contracts, keeping net leverage around 4.8x and maintaining a regular dividend. If portfolio management, cost controls and disciplined capital allocation continue, that could support AFFO stability and investor confidence more than a bearish thesis assumes.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for OUTFRONT Media is $19.0, which represents up to two standard deviations below the consensus price target of $24.2. This valuation is based on what can be assumed as the expectations of OUTFRONT Media's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $28.0, and the most bearish reporting a price target of just $19.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $2.0 billion, earnings will come to $228.0 million, and it would be trading on a PE ratio of 18.2x, assuming you use a discount rate of 9.1%.
  
• Given the current share price of $23.71, the analyst price target of $19.0 is 24.8% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.