– Graham Holdings stock suffering mainly from COVID-19 economic shutdowns
– As world economy recovers after COVID-19 containment, GHC could rise 20%
– Lowly valued stock could rise 50% long term as GHC returns to historical growth rate
I’m looking ahead to a time when the coronavirus (COVID-19) is eventually contained and economic activity resumes. That said, if you don’t agree with that assessment, that the world economy has worsened permanently, then stop here.
As COVID-19 fears fade, I view Graham Holdings (GHC) as undervalued. On Wednesday, the (class B) shares were quoted around $344, up from $268 at the market’s March bottom, but still down from $756, the 52-week high. The current stock level was first reached back in 2013, when GHC earned $32 per share (including the cable business that was spun out in 2015). EPS was $61 in 2019. More on this below. GHC offers an unusual mix of businesses, spanning education services (half of revenue) to media (broadcast) to manufacturing, healthcare and even restaurants.
There are a number of factors in favor of this depressed stock, but the main catalyst, as I see it, is a return to a more normal world economy, which could mean a 20% rise in the medium term. Longer term, I believe GHC could return to its traditional growth rate, command a better multiple, and could be up 50% from current levels.
1-The first intangible to note can’t be gleaned by any stock screen: the effect of Warren Buffett on the company, notes Marty LeClerc, who runs Barrack Yard Advisors, which owns GHC shares for clients. In the 1970s Buffett joined the board of GHC (its biggest asset then was the Washington Post), and imbued Katherine Graham, whose family controlled the company (and does now), with his rigorous style of investing and capital allocation. It appears that corporate culture continues to hold at GHC, adds LeClerc.
GHC has evolved from a media company to an educational services company and in the future will likely evolve again. In 1999, the company relied on media, providing 51% of operating income compared to a $31 million loss by Kaplan educational services. By 2009 media income was gone but Kaplan’s rose to $242 million, mostly Kaplan Higher Education, which has thousands of client schools and serves 1.1 million students, twice the number from 2015. Today, the latter has suffered in the last three years, but other levers, like Kaplan International, are growing and filling the hole. The point is good capital allocation.
Two examples of GHC’s capital allocation was its spinout of unit Cable One (CABO) in 2015. At the time, GHC was about a $6 billion company. As a shareholder, if you kept shares of both GHC and CABO, today you would own two companies with a combined value of $12 billion, $2 billion of GHC and $10 billion of CABO. And GHC sold the Post to Jeff Bezos. Conglomerates are often unwieldy, but GHC is run like a private equity investor, opines LeClerc. Its assets are continuously evaluated and evolving.
2-I think the diverse set of businesses, including restaurants, cybersecurity, healthcare and podcasting, allow GHC to better withstand secular issues that happen to hit one of them. For example, the Kaplan test prep for professionals and students seems to be weakening from competition and school closures, perhaps even in a secular way, though I don’t think this is a foregone conclusion. However, its online learning business could benefit from ongoing school closures.
And Kaplan International, which serves universities and international students, is growing nicely. Healthcare, which is relatively new, is also becoming more and more important. I expect that five years from now GHC will not look exactly like the current edition, just as the 2020 version is very different from 2010 and that, in turn, from 1999.
3-I think it’s interesting and a bullish sign, too, that insiders, directors and managers, bought shares in late February and March. According to insiderinsights.com, which follows such activity closely, the recent buying at GHC by corporate executives is rated bullish. It’s a holding company where insiders have plenty of skin in the game, LeClerc notes. That’s all to the good.
4-GHC shares are significantly cheaper than it has been in a long time. LeClerc notes the stock trades at about 6.5 times EV/Ebitda, much lower than its long-term average of 9-10 times. The price/earnings and price to book ratio is similarly depressed versus history. GHC effectively has little net debt (about $200 million), a strong point in these times. Cheap can stay cheap, but as COVID-19 fears recede and the world economy revives, so should GHC’s stock.
Many factors hurting GHC are, to a great extent, not fundamental. Apart from the aforementioned COVID-19, GHC is not in any important index (due to the Graham family control though class A shares) and is somewhat less liquid with that high stock price. And it has no Wall Street analyst coverage. Another reason GHC doesn’t screen well is that its sales and acquisitions, among other factors, makes results “noisy,” with one-time gains and losses that complicate valuation assessments. It’s also a unique animal with no pure competitor that investors can compare it to.
After a 7% drop following the poor earnings news Tuesday, the stock seems “washed out.” GHC reported a first quarter net loss of $33.2 million, or $6.32 per share, compared to net income of $81.7 million, or $15.26, in the year ago period. The company attributed most of the impact to COVID-19. Revenue was $732.3 million, up 6% from $692.2 million in the first quarter of 2019, largely due to the acquisition of two automotive dealerships in January 2019 and the acquisition of Clyde’s Restaurant Group in July 2019. Again, there’s the “noisy” results. Revenues grew at healthcare and television broadcasting, partially offset by declines in education. Healthcare continues to grow in importance.
Where I could be wrong: COVID-19 becomes a long term habitually occurring problem hurting GHC’s various businesses, particularly education, permanently.
Bottom Line: With a tradition of good capital allocation, and a cheap stock—mainly due to Black Swan event that I believe will not fundamentally alter its growth profile permanently, even the restaurant business—in the long run, three years out or more, the stock could eventually rise 50%.
Prior “Signals”
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4/8/20 | Stock | Galapagos (GLPG) | If Galapagos Arthritis Drug Is Approved, Stock Looks Cheap |
4/1/20 | Stock | DaVita (DVA) | In Uncertain Markets, DaVita’s Stable Rev/EPS Look Attractive |
3/25/20 | Q&A | InsiderInsights | In Roiled Market, Insider Activity Could Offer Directional Clues |
3/18/20 | Market | US Stock Market | Market Discounts Recession; GDP, EPS Growth Worries Mount |
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2/26/20 | Market | South Korean Stock Market | When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap |
2/19/20 | Q&A | Atlantic Investment Management | Atlantic’s Concentrated Approach Yields Strong Returns |
2/12/20 | Stock | Casper Sleep (CSPR) | Casper Stock Might Not Let You Get a Whole Lot of Sleep |
2/5/20 | Stock | Arch Coal (ARCH) | After Sentiment Plunge, Arch Coal Stock Looks Inexpensive |
1/29/20 | Sector | Healthcare | Healthcare Looks Inexpensive; Some Healthy ETFs to Play |
1/22/20 | Stock | Spirit Airlines (SAVE) | Why Spirit Airlines Shares Could Take Off in 2020 |
1/15/20 | Market | 4Q19 EPS Season | Market to Focus on SPX EPS Growth after 4Q19 EPS Season |