Two Cities follow-on validates Studios strategy

STV has today announced an increased investment in Two Cities, a leading drama producer into which the group invested in January 2020 (just prior to the Covid outbreak). Two Cities is performing well, with a strong pipeline of series already approved and a £55m secured revenue base over the coming three years. We see this commitment by STV as further proof of the strong and long-lasting growth in the Studios business as a whole. Relatively low-risk (small) investments have been made in a number of areas, and this follow-on deal suggests that the strategy is delivering well.

Two Cities follow-on validates Studios strategy

News that economic pressures are impacting on STV’s trading is perhaps not surprising; we reduce estimates in line with updated guidance. The update underlines the value of STV’s ongoing diversification across Digital and Studios, with continued strategic progress in these areas. The group financial position remains sound, valuation remains modest even on lower estimates, and we continue to expect a return to good overall growth, driven by Digital and Studios, once the UK economy stabilises.

Weak economy, strategy on track

STV’s H1 results confirm a picture of continuing uncertainty in the UK economy and advertising markets (albeit Q3 should be positive due to sporting events), driving a reduction of 8%-9% to FY EPS estimates. As market leader though, STV is very well placed to benefit when the ad market recovers, with every 1% of advertising uplift having a material positive impact on EPS. STV also continues to make vigorous progress in its diversification strategy. Growth in both Digital and Studios businesses (forecasts unchanged, now 69% of profits) should also drive future growth for the group.

Strategic progress in tough ad markets

STV is broadly doubling the size of its Studios division with the acquisition of production business Greenbird Media for c.£24m. Strategically this looks transformative for STV Studios, and further diversifies the group outside of Broadcast. We conservatively estimate 5% EPS accretion, and financial ratios remain very comfortable even with the higher debt.

Transformative acquisition for STV Studios

Several recent announcements highlight that STV is continuing to execute its diversification strategy effectively, even in a tough economy. We summarise the developments in this report, consider further possible newsflow to come from STV and recap the investment case. At 249p, current valuation is 7.3x EPS / 4.5% dividend yield (FY23E).

Continuing operational momentum

STV Group’s FY22 results and FY23E outlook, announced this morning, are in line with expectations. The resilient performance through the economic downturn (adjusted PBT +2% in FY22 and we forecast -10% for FY23E) underlines improving earnings quality from STV as the group continues its diversification from broadcast to streaming and studios, which together should generate over half of group profits for the first time in FY23E. We forecast good aggregate growth prospects for the broadening portfolio, at an undemanding valuation (8.9x ‘bottom of the cycle’ FY23E EPS with a 3.7% dividend yield).

Resilience from diversification

STV continues to be viewed as a mature broadcaster, yet it is transforming into a growing streaming and production business. We see continued double-digit growth prospects in these areas, together with a resilient broadcast business, and calculate five-year growth of 7% pa in revenue / 10% pa in operating profit for the group (FY23E-FY28E). Near-term economic pressures are factored into current EPS estimates, but should also drive eyeballs towards STV’s free AVOD service. Current valuation (7.6x FY23E EPS / 4.3% dividend yield) looks modest given the longer-term potential.

Towards streaming and content