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Yesterday (24 July), ITV (LSE:ITV) shares rose 13% to post fresh 52-week highs. This in itself is enough to attract considerable attention to the FTSE 250 firm. Yet, based on current valuations and the outlook from here, I think it could be ready to embark on a broader rally in the coming months. Here’s why.
Reason for the spike
The main factor that caused the jump was the release of half-year results. On the face of it, some might be surprised, given that total revenue for H1 was 3% lower than the same period last year. Group adjusted EBITA was 31% lower year-on-year. However, this wasn’t as bad as people had expected, so there’s some optimism already.
Some of the factors that helped the business outperform analyst expectations were the demand for ITV Studios’ initiatives and a 9% increase in digital revenues from ITVX.
Investors welcomed the news of the launch of a new £15m cost-cutting programme, bringing the total savings for the year to £45m. It shows that management is aware of the changes needed to get the business back on track after a disappointing few years and is taking action.
The bottom line here is that the results weren’t great, but they weren’t as bad as expected, with several reasons to believe that the worst is now behind us.
A brighter outlook
I believe the share price has the potential to outperform from here. Some investors are still pessimistic about the company. I understand that, and a key risk is that future results may underwhelm, as the cost-cutting could be too drastic too soon.
Yet if we assume management’s got the numbers correct, then a more streamlined ITV bodes well for future profitability. If costs can be kept under control, the focus then turns to revenue. I think this can increase going forward, based on ITV Studios continuing to grow.
Interestingly, revenue from this area grew by 2%. At £893m, it accounts for an increasing proportion of the £1.8bn total group revenue. If this trend continues, it can not only help to offset other underperforming areas but also lift the overall revenue figure alone.
The culmination of lower costs and increasing revenue should result in higher profits. This is where the price-to-earnings ratio comes in. At the moment, the ratio’s 8.07. This is below the fair value figure of 10 that I use. If earnings increase from here, the share price will also need to increase to maintain that ratio. Yet I’d argue the share price should rally by a greater amount, pushing the ratio beyond 10 in order to make the stock fairly valued.
I appreciate my views on what could happen from here are subjective. Yet, based on the strong results just released and the outlook from here, I’m seriously considering adding the stock to my portfolio.
