VICI Properties (VICI):  VICI reported its typically boring quarter with results in line to slightly better than street expectations.  Boring is exactly what we like about VICI.  As a landlord to the nation’s two leading gaming companies, Caesars and MGM, VICI’s business model is highly predictable.  The company collects rents with built-in escalators.  Beyond the annual rent increases, VICI also grows by buying other casino properties.  Essentially, VICI acts as a financing partner for casino companies.

While 1Q22 offered little news in the reported results, it was a critical quarter for VICI.  The company closed on its acquisition of The Venetian, one the most significant properties on the Las Vegas Strip.  VICI also completed its merger with MGM Properties, combining the two largest Gaming REITs.  With the big deals closed, VICI issued updated guidance for the combined company that was in line with our estimates and slightly ahead of street estimates.  VICI pays out most of its earnings in dividends but there is several hundred million left over that the company uses for additional acquisitions that are smaller in scope than Venetian and MGM transactions.

We think a period of calm will be good for VICI shares as the power of the enlarged company can shine.  VICI is now one of the three largest REITs by market capitalization, something we believe will be a source of incremental demand from real estate focused investors.  The shares currently have a dividend yield of 5% and we expect dividend growth to be in the mid-single digits annually.  We expect the multiple to expand as investors gain appreciation for VICI’s business model and the acumen of its superb management team.  After never missing a rent payment during peak COVID, when many of its tenants shut their casinos, we have little concern about credit risk even if the economy slips into recession.  The primary risk in the shares is rising intermediate to long-term interest rates that weaken the relative value of VICI’s dividend yield. The combination of dividend yield, moderate earnings growth, and multiple expansion offers VICI shareholders upside of 15-20% in the next twelve months and a long-term return profile of 8-10% annually.

Nexstar Media Group (NXST):  Over the nearly ten years that we have been investing in NXST, we have grown accustomed to good earnings reports that meet or beat expectations and steady increases in estimates of free cash flow (NXST and other local TV station owners are valued primarily on free cash flow rather than EPS or EBITDA).  In our long history with NXST, 1Q22 was one of the best quarters.  Revenues, EBITDA, and free cash flow each comfortably exceeded our own and Wall Street estimates.  Perhaps more importantly, management indicated no slowdown in advertising or the net retransmission fees it receives from cable, satellite and vMVPDs (YouTube TV, Sling, Hulu Live TV) despite the war in Ukraine, rising inflation and interest rates, and investor fears of an imminent recession.  Other local TV broadcasters offered similar comments.

We attribute the company’s outlook and performance to its best-in-class management team that executes flawlessly on sales, expense control, free cash flow conversion, and mergers and acquisitions.  On its 1Q22 conference call, management noted multiple times that its three-year outlook is strong and has high visibility.  Political advertising looks set for one of its biggest years ever this year with control of the House and Senate at stake.  The Presidential election in 2024 will surely be hard fought and the House and Senate will likely still be close to evenly divided.  Retransmission fees should take a step up as a new round of negotiations is underway with local TV channels still underpriced relative to their viewership share.

NXST will generate free cash flow of about $1.4 billion per year in 2022 and 2023, which equates to over 20% of the current stock price.  Capital allocation includes steady increases in the dividend, significant share buybacks, and tuck-in acquisitions of digital properties that enhance the national reach of the company’s TV station group.

NXST shares reached $190 before the market correction.  We think the stock can get back there and reach $210 assuming 2022 and 2023 results meet expectations.  The primary near-term risk is a recession that impacts the company’s advertising.  However, core advertising (non-political ads) is only around 30% of revenues now vs. 80% during the 2007-2009 Great Financial Crisis.  Despite what many investors think, local TV broadcasters are not particularly economically sensitive.  Long-term risk emanates from changing TV viewing habits that could reduce time spent with the company’s local news broadcasts.

Sony (SONY):  SONY reported results in line with investor expectations for 4Q21 (which ended on 3/31/22).  Looking at the full fiscal year, operating income came in about 20% above initial guidance.  SONY typically guides conservatively.  This gives us great comfort that the newly issued guidance for a small decline in operating income in FY22 will prove conservative.  This especially appears the case in the company’s Gaming segment where management is guiding to a 34% revenue gain but unchanged operating income.  Guidance in Music calls for continued growth fueled by streaming and label acquisitions.  Image Sensors used in mobile phone cameras should grow as well although COVID lockdowns in China could prove a challenge for the supply chain.  Pictures will have a down year comping against the massive success of the latest Spiderman movie, which is one of the all-time box office leaders.  These four businesses provide the bulk of SONY’s earnings and are key to why we think the stock is significantly undervalued.  SONY shares have performed poorly this year, pressured by fears about the impact of Microsoft’s proposed acquisition of Activision Blizzard.  SONY and Microsoft are big rivals in gaming consoles (PlayStation vs. Xbox).  The stock has also been under pressure due to significant weakness in the yen vs. the dollar and multiple compression that has hurt all growth stocks.

We are encouraged by the recent improvement in SONY shares relative to the market.  SONY shares are unchanged since April 27, while the S&P 500 is down 6% and the NASDAQ is down 7%.  We think this is just the start of improved performance for SONY.  The stock trades at less than 8X EBITDA while peers in the video game, music, semiconductor, and film and TV production industries trade at significantly higher multiples.  SONY’s results are never linear due to the company’s complexity and conservative financial reporting practices.  However, we expect the company to materially beat its 2022 forecasts and its recently issued three-year forecasts.  This should allow multiple expansion to 10X, which gives us a target of $120, up more than 40% from current trading levels.

Disney (DIS):  DIS shares have been the worst performer in the Dow Jones Industrial Average so far this year, driven lower primarily by the collapse in Netflix shares.  Netflix’s weak subscriber growth and lowered profit margin forecast have undercut confidence in DIS’s own transition to streaming despite better-than-expected growth in subscribers at Disney+.

DIS had solid results in 2Q22 but cautious comments on the company’s conference call for the balance of FY22 have pushed the shares lower again.  Higher expenses in streaming reinforce the worries triggered by Netflix’s margin guidance.  Investors are asking if streaming will ever produce material profits.  Netflix also has raised worries that DIS subscriber growth will fall short of management’s expectations of 230-260 million at Disney+ in 2024 (currently near 140mm).  On the 2Q conference call, management noted that the incremental growth in subs in 2H22 vs 1H22 would be less than previously forecast.  Investors interpreted this news negatively, but we would point out that 1H22 sub growth came in well ahead of expectations and there is no change to the number of new subs expected in 2H22.  We remain confident that streaming subs are on track given many new countries are being launched later this year and a surge in fresh content is coming now that COVID is no longer impacting production schedules.

While we wait for clarity on long-term streaming trends, Disney’s theme parks are booming.  Domestic theme parks are already operating well ahead of 2019 pre-COVID levels and international visitation has barely restarted.  If we value DIS at 12X EBITDA reflecting a premium for theme parks and the film studio and a discount for traditional media, we get a value of $100 per share.  This approach embeds a multibillion-dollar loss on streaming.  At our 12X multiple, this equates to $30 billion of market cap or about $20 per share.  Netflix may face growth concerns, but it is profitable today and valued at $90 billion.  Each $10 billion in value ascribed to DIS streaming is worth about $4 a share.  We feel extremely comfortable valuing DIS streaming at 80% of Netflix which would equate to a target of $130 for DIS.  We feel this target is conservative but realistic until investors regain confidence in long-term streaming economics.  While $130 is well below targets of over $200 we held previously, it is enough to keep us long DIS shares ahead of what we hope will be better news on streaming later this year.

Home Depot (HD):  HD reported excellent 1Q22 results and, in an unusual move, raised its full year guidance.  The news was good in almost every area with profit margins a highlight for us after so many recent quarters where margins seemed to trip up the investment thesis.  Good margin performance contrasted with the big earnings misses and guidance reductions at Walmart and Target due to the impact of inflation and supply chain problems.  The conference call overall was quite bullish, much more so than in we usually hear from HD’s conservative management team.

Unfortunately, HD shares gave up all their initial gains and fell sharply along with the rest of the retail stocks after the plunges in Walmart and Target stocks.  If there was one issue that worried HD investors, it was related to composition of the 3% comparable store sales gain.  The gain was made up of 11% price increase and an 8% decline in traffic.  Given current Wall Street worries about a recession driven by a pullback in consumer spending, the traffic decline is worrisome.  However, HD reminded investors that (1) it gets a significant portion of its sales from contractors or Pros, and (2) Pro demand reflects the spending by consumers.  Management also offered an interesting take on housing economy as it relates to the sharp jump in mortgage rates this year.  To summarize, there are about 130 million housing units in the US of which 100 million are either single family homes or non-rental properties.  Turnover of these homes in a typical year is 4-5 million units.  Of the reaming units, about 85% have fixed rate mortgages.  These statistics suggest that the impact of higher mortgage rates is less than generally perceived.  Furthermore, management noted if homeowners feel unable to move because of higher mortgage rates on their new purchase, they may decide to invest more in their current home.  It crossed our mind that a shorthand way of saying this is that the industry is referred to as home improvement not new home construction.  Northlake would also believe HD is getting a boost from a secular shift of consumer budgets to the home driven by the COVID experience.  We continue to find HD shares attractive with a current target of $340 based on 15 times EBITDA or 20 times projected earnings.  This target is below our earlier targets since the market multiple has contracted sharply but provides plenty of upside for a blue-chip company in a tough market environment.

VICI, NXST, SONY, DIS, and HD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.