oOh!Media (ASX:OML) is considered well leveraged to the recommencement of airline travel, easement of social restrictions, and improved business confidence. Indeed, results for the 12 months to 31 December 2020 (FY20) indicate that the Company has so far navigated the challenging operating environment well.
To this end, we recently reviewed the Company to assess the extent and timing of the likely recovery in volumes for each of its key operating segments. Further, is the Company able to generate further cost savings and mitigate contract expiry risk in order to ensure that the recovery in volumes is reflected in earnings growth?
oOh!media (OML) operates in the Australian and NZ out-of-home advertising industries and has the leading market share in each of its operating segments in Australia and NZ. The Company, which has a 31 December balance date, has an extensive network of more than 37,000 digital and static asset locations. These include roadsides, retail centres, airports, train stations, bus stops, office buildings, cafes, bars, and universities. The operating segments comprise:
• Commute (35% of group revenue), which consists of the Company’s street furniture and rail assets.
• Road (28%), comprising metropolitan and regional roadside billboards.
• Retail (25%), comprising shopping centres, with a significant exposure to Tier 1 retail shopping centres.
• Fly (5%) – OML’s airport assets are weighted more towards domestic travel.
• Locate (3%) – includes cafes, pubs, universities and indoor social sports centres.
Key Fundamental Considerations
Travel Sector Presents the Biggest Challenge to Volume Recovery
While advertising revenue out to FY25 is expected to exceed pre-COVID-19 levels in Road and Retail, Fly and Locate are expected to experience a more gradual recovery. Office- and Rail-related revenues continue to be impacted by reduced audiences, and are expected to recover in FY21/22. It is worth noting that Rail and Locate are likely strongly correlated. This is given that a return to offices accompanied by an uplift in the use of public transport
The Fly segment faces obvious (and the greatest) headwinds in terms of returning to pre-COVID-19 levels. Whilst the Fly segment represented a low proportion of group revenue pre-COVID-19 (FY19: 10%), it is considered a key growth segment. A key factor underpinning expectations for a strong recovery for the Fly segment is that OML’s airport assets are weighted more towards domestic travel. This can be expected to recover more quickly than international travel when COVID-19 air travel restrictions are lifted.
OML noted passenger assumptions for airports are expected for a domestic return in late 2023 and international in late 2024 The Fly segment has historically represented a low proportion of group revenue, but is considered a key growth segment for OML.
Can Costs Continue to be Managed Well?
Cost savings supported the FY20 result, as the Company received net rent abatements. This was mainly from landlords in the highly-impacted Airport, Rail and Commuter environments. OML has a heavy skew towards fixed rent agreements. Rental expenses in the Fly, Office and Rail formats have a larger variable component than the broader business, and benefitted from key concession partners providing rent relief.
Further rent abatements are expected in FY21. However, only ~30-40% of the level received in FY20 and are subject to audience/revenue and the outcome of ongoing negotiations with landlords. Notwithstanding, the lower level of rental abatements in FY21 is not expected to impact earnings, as there is potential for the Company to offset this through a recovery in revenue.
In FY21 and beyond, cost growth is expected to return, given the increasing exposure to digital out-of-home advertising. In particular, the growth in operating expenditure over a number of years pre-COVID-19 was due to the need to undertake continued spending on digital sales (as the portion of digital sales continues to increase) and technology. Investments in these areas are considered necessary. They offer increased operating leverage as digital sales becoming increasingly sophisticated, incorporate increasing amounts of data, and continue to evolve to increase platform efficiency for advertisers and improve yields for OML.
A key potential offsetting factor to higher cost growth beyond FY21 is that the Company will look to achieve further rent reductions beyond FY20 as sites and negotiations come up for renewal. Of course, this assumes that the Company is able to retain existing contracts on (at least) similar pricing terms.
Contract Expiry Risk Profile Considered Manageable
FY21 is the biggest year for revenue maturity until at least FY25. Approximately 20% of FY19* revenue is attached to contracts due to expire in FY21, due to the rollover from FY20. Of the $125.6m in revenue due to expire in FY21, $60-70m of contracts are in holdover status (leases that consistently roll over post their original expiry date).
The Melbourne Airport contract has been renewed, whilst the Sydney Trains contract is still under negotiation. In terms of the relative profitability of these contracts, both have counterparties which are highly sophisticated (i.e. low-margin contracts with high variable “pay-aways”). Furthermore, average contracts are long-term in nature (~5-6 years) and no single contract comprises >6% of group revenue and contract renewal processes are an ordinary course of any Out-of-Home operations.
Gearing Level Is Comfortable & Reducing
Helped by a substantial capital raising in April 2020, OML’s gearing level is lower than that of recent years. Prior gearing was elevated as a result of the Adshel acquisition, which was partly-funded by additional debt of $260m.
Importantly, the gearing level is expected to fall further in FY21 and FY22, as the level of free cashflow is supported by only a moderate increase expected in CAPEX. In FY20, CAPEX was materially scaled back in response to COVID-19. For FY21, CAPEX is expected to be below pre-COVID-19 levels and focused on revenue growth and concession renewals. Also, dividend payments are expected to a return in 1H22, after a final dividend was not paid.
The shares are currently trading on a 1-year forward P/E multiple of ~22x and while this appears moderate in light of expectations of strong EPS growth over FY21-23 (~48% on a CAGR basis), there are still some risks to consider:
i. The risk of contract losses and/or unexpected costs associated with contract renewals;
ii. The shortening revenue profile of the industry. As referred to earlier, the Company has a high fixed-cost base but have very short-term revenues with site bookings.
iii. Uncertainty around the timing and extent of volume recovery in the Fly segment and, to a lesser extent, the Locate segment.
When we looked at the OML chart 5 weeks ago, we expected it to rally, with a major test being the December high. As we can see, it rallied strongly a few days later but was sold down when it got near $1.90. At the moment it is holding on above the March low, which is a positive for the time being. At the moment it looks as though the OML share price can continue to edge higher – it just needs to stay above $1.60.
* For comparative purposes, FY19’s revenue base has been used, as this represents a truer picture of the revenue opportunity attached to various leases and their relative expiry profile compared to FY20 which was significantly impacted by COVID-19.
Michael Gable is managing director of Fairmont Equities.
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