Warner Music Plays a Sad Tune

“A surprise quarterly loss for Warner Music as the weak economy and slowing demand for CD’s resulted in a three cent a share loss. Analysts were looking for five cents a share.” — CNBC’s Closing Bell 11/24/2009

One of the world’s largest recording companies, Warner Music Group (WMG), closed fiscal 2009 with a surprise loss of three cents a share excluding items. The company lost $18 million or 12 cents per share, but it narrowed to three when taking out $14 million of charges related to shifting marketing efforts from CD sales to digital music sales. Wall Street was looking for a profit of 5 cents per share and hoping for strong sales of big-name releases in the quarter.

Warner Music cited weak economic conditions for shaky sales in the U.S. However, overall sales were better than expected coming in at $861 million a gain of 1% versus estimates of losing nearly 4% in the quarter. International sales improved by 8.8% or 17.8% when excluding the impact of currency exchanges, which helped to make up for the 7.4% declines domestically. Digital sales were also a source of growth for the company rising 10% or 11.5% on a constant currency basis.

For the year, revenue fell 9% and the company lost $100 million or 67 cents per share. The industry is still clearly in a transition period from disc sales towards digital format sales, as the rise of the iPod has all but taken over the disc man and CD case. Digital sales now comprise 21.4% of the company’s overall revenue up from less than 20% last year, and we expect that share to continue to grow in the years ahead. However, we also expect the company to continue to be challenged by consumers’ thrifty behavior with their discretionary purchases, and pirating of music is a constant challenge.

The stock finished an extremely volatile trading day down more than 12 percent, as the surprise loss was an unwelcome reminder of some of the challenges facing WMG. There has been a noticeable decline in the fundamentals for the firm; however, the price does not seem unjustified according to our methodology. For example, despite the drop in sales over the last two years the stock price has fallen along with it. Historically speaking, WMG has traded within a price-to-sales range .28x to .84x, and the current level is about .33x. The fact that they continue to struggle below break even is obviously a significant problem in our analysis. We are maintaining our Fairly Valued rating as of right now, and we are unlikely to downgrade after today’s fall in price.

Warner Music Plays a Sad Tune

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