Warner Bros. Discovery (WBD) is a large entertainment industry business with a market cap of ~$26 billion; the stock is a top speculative pick for the coming year, explains Ben Reynolds, editor of Sure Dividend.

The company in its current iteration was created on April 8th, 2022, when AT&T (T) spun-off its WarnerMedia operations, which combined with Discovery’s operations to form Warner Bros. Discovery. It owns a host of well-known entertainment brands, including: HBO, Discovery, Warner Bros., HGTV, CNN, TNT, TBS, DC, Cartoon Network, New Line Cinema, and many more.

Warner Bros. Discovery’s stock has not performed well since the new company formed. The stock price has declined from over $40 per share to under $11 per share at the time of this writing.

The company has failed to immediately generate the synergies and cash flows that were expected when it was created. In addition, Warner Bros. Discovery is settled with a large debt load. The company had net debt of $47.9 billion at the end of its third fiscal quarter in 2022.

But even with the large debt load and relatively poor performance ‘out of the gate’, there’s a lot to like about Warner Bros. Discovery. First, the company is aggressively paying down debt. The company has already paid down $6 billion in debt through September 2022. Future debt paydowns are likely.

Warner Bros. Discovery also has the ability to continue to pay down its debt thanks to its strong free cash flows. The company expects to generate $3 billion in free cash flow in fiscal 2022. And that number is expected to rise to $4 billion to $6 billion in 2023 as the company realizes synergies from its combined operations and streamlining decisions (which include cutting CNN+).

With a market cap of ~$26 billion, Warner Bros. Discovery is trading for just ~8.7x its expected fiscal 2022 free cash flow. For comparison, I believe a price-to-free-cash-flow ratio of ~15 is reasonable for a company with high quality brands like Warner Bros. Discovery.

On the downside, the company does have excessive debt, but that is manageable and declining. The company appears inexpensive today based on cash flows. But it really stands out for the long-term investor. Warner Bros. Discovery expected $5 billion in free cash flow in fiscal 2023 based on the midpoint of its guidance. It’s trading for just 5.2 times its expected fiscal 2023 free cash flows.

In my view, this is far too low. If the company traded for just a 10x multiple of free cash flow by the end of 2023, this would imply a $50 billion valuation, nearly double the company’s $26 billion market cap.

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