Surya Citra Media In a Sweet Spot

We maintain our BUY call on Surya Citra, with a higher IDR3,700 TP (from IDR3,300, 22% upside). We expect the industry to recover as a result of better FY16 consumption. In such an event, the company may have an advantage due to its strong audience share, which could lead to better rates. We also anticipate margins to improve from having less USD-based content. We expect earnings to grow at 16%/18% in FY16/FY17.

Recovery in the media industry
We expect consumption to improve from 1H16 onwards, which could lead to a better outlook for the media sector. Surya Citra Media’s (Surya Citra) consistent performance in terms of audience share growth could lead to better advertising (ad) revenue in the event of a recovery for the sector. We estimate the company to record top line of IDR4.9trn (FY16) and IDR5.6trn (FY17).

The top line improvement in FY16 may be supported by both its TV stations – Surya Citra Televisi (SCTV) and Indosiar – for which we assume higher rates and less discounts handed out. This is given their strong audience share on top of wider margins, resulting from the discontinuation of USD-based content and an increase in in-house produced programmes.

Margins expansion on less USD exposure
In 1H15, Surya Citra discontinued the screening of the European Champions League football matches and this has led to better margins in 3Q15. Furthermore, as it is also planning to discontinue broadcasting Barclays Premier League matches in 1H16, we expect its content costs to decrease in FY16, which could improve its margins. We expect EBITDA margins to improve to 50% (FY16) and 51% (FY17). Content from the European Champions League and Barclays Premier League are expensive and only offer a thin profit margin.

Maintain BUY, with a higher IDR3,700 TP (22% upside)
We think the market has not priced in the potential improvement in ad revenue for Surya Citra; even though the stock now trades at a premium valuation, we believe it still offers a potential upside in the event of an economic recovery. Our DCF-based TP implies 31.1x/26.4x FY16/FY17 P/Es. Risks: i) Indonesia’s economic recovery is slower than expected, and ii) the transition to digital TV.

Expect Strong Ad Revenue From Both TV Stations
Expect a better top line for Surya Citra in FY16. We expect consumption to improve from 1H16 onwards, which could lead to a better outlook for the media sector. Surya Citra’s consistent audience share growth could lead to it booking better ad revenue in the event of a sector recovery; we expect it to book top line of IDR4.9trn in FY16 (+14.7% YoY growth) and IDR5.6trn in FY17 (+15% YoY growth).

The top line improvement in FY16 would be supported from its two TV stations SCTV and Indosiar – for which we assume higher rates and less discounts handed out. This is given their strong audience share numbers and better margins stemming from the discontinuation of USD-based content and more in-house production.

Rate card improvement due to stable audience share
Over the past few years, SCTV and Rajawali Citra Televisi Indonesia (RCTI) had been the two biggest players in terms of audience share and ad revenue. Hence, they have more bargaining power to increase their rate cards and offer lower discounts to the advertisers. Therefore, we expect Surya Citra’s TV station, SCTV, to be able to increase its rate card by 10% in FY16.

Indosiar is the next driver for Surya Citra
The introduction of variety shows like D’Academy was a big success for Indosiar. Note that D’Academy was aired for 3-4 months (Feb-May 2015) and, during this period, Indosiar’s prime time audience share increased to an average of 20% in FY15. However, the station’s prime time audience share experienced a free fall to 11.6% on average between Jun-Sep 2015 once D’Academy went on hiatus. At the end of FY15, Indosiar began airing its D’Academy Asia programme, which drove the prime time audience share up to an average of 16% in Oct-Nov 2015.

The success of musical variety shows like D’Academy in FY14 and FY15 could translate into higher sponsorship payments in FY16. Music shows have a different method of obtaining ad revenue. For a drama series, advertisers would examine a TV station’s audience share rating for three months before deciding whether or not to place their ads.

Even if they do place ads, the contract would be reviewed monthly, dependent on the channel’s ratings. However, for musical variety shows, advertisers would be willing to pay to advertise even before the show is aired. This means that, in FY16, Indosiar could charge a higher rate card. This is following the success of the show in FY14 and FY15, as seen by the higher audience share attracted.

In-house production and fewer USD-based programmes helped boost profitability
Surya Citra has utilised its efficient in-house production team to provide its programme content. Currently, 70-80% of its programme content comes from in-house productions. They are also cheaper – vis-à-vis outsourced production – with the cost of movies produced in-house at around IDR200m-250m vs outsourced production’s IDR300m-350m. Additionally, a third of ad revenue generated from the broadcast of outsourced programmes is paid to the outsourced party as a performance bonus.

Besides that, we expect Surya Citra’s content costs to be lower going forward as its European Champions League foreign contract ended in 1H15 while its Barclays Premier League contract is set to end in 1H16. While these two programmes are highly anticipated with good ratings, they do not generate good profitability for the company as the cost to buy the licences is expensive. We believe both programmes could be replaced by Surya Citra’s drama series and music shows.

Expect margins improvement
An increasing number of in-house programmes and the discontinuation of European Champions League and Barclays Premier League broadcasts could improve Surya Citra’s GPM. We estimate FY16/FY17 GPM at 64.2%/65.9% respectively, driven by lower USD-based content and cheaper production costs.

Premium valuation is justifiable
Surya Citra currently trades at 25.6x 1-year blended forward P/E, a premium to its peer Media Nusantara Citra’s (Media Nusantara) (MNCN IJ, BUY, TP: IDR2,150) 11.8x 1-year blended forward P/E. We believe the premium valuation for Surya Citra is justifiable. This is given its better returns and profitability margins, above ROEs and healthy balance sheet (no USD debt exposure).

Furthermore, we think that its premium valuations in FY15 were due to better earnings despite the macroeconomic challenges. In our opinion, the market has not priced in the potential higher ad revenue for Surya Citra, as we think that both its TV stations (SCTV and Indosiar) could improve their rate cards and give lower discounts to advertisers. Although the stock is now trading at a premium valuation, we believe it still offers a potential upside should the economy recover.

Valuations
We assume a risk-free rate of 8%, market risk premium of 5%, equity beta of 0.9 and terminal growth rate of 3%, which results in a WACC of 10.7%. We believe that DCF is the most appropriate valuation methodology, as it captures Surya Citra’s long-term growth prospects.

In our new assumptions, we estimate higher ad revenue growth for Surya Citra at 14.7%/15% for FY16/FY17 respectively. This is from 12.5% (FY16) and 14.8% (FY17) previously. We believe that Indonesia’s economy should start recovering in 1H16. Going forward, we expect the company to see: i) a rate card improvement and lower discounts offered given its high audience share, ii) margins improvement from the discontinuation of European Champions League and Barclays Premier League broadcasts, and iii) lower content costs as it uses more in-house programmes.