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Is Morgan Stanley Right About CBS?

Morgan Stanley analysts have recently been making the case that CBS Corporation (NYSE:CBS) is undervalued, setting a price target of $40 per share. The closest thing to a publicly traded broadcast and cable network- with NBC, ABC, and Fox properties all under the umbrellas of Comcast Corporation (NASDAQ:CMCSA), The Walt Disney Company (NYSE:DIS), and News Corp (NASDAQ:NWSA) respectively- is up 22% so far this year, outperforming the broader market indices. We certainly can’t say that the stock is expensive at the current market cap of $21 billion: its trailing P/E is 15. At $40 per share- roughly a 20% increase in price- it would trade at 18 times trailing earnings.

CBS Corporation did have its revenue decline by 3% in the second quarter of 2012 compared to the same period in 2011, but lower operating costs made up for the reduction in business and so the company reported an 8% increase in earnings. With share count falling as well, earnings per share grew from 58 cents to 65 cents. This followed a strong improvement in CBS’s first quarter as opposed to Q1 2011, and so the company reported EPS of $1.19 for the first half of the year. That actually equates to a current-year P/E of 14 if annualized. For a company which has been getting at least some earnings growth recently and pays a dividend yield of 1.4%, that seems cheap. Wall Street analysts expect continued steady growth, and so CBS trades at 12 times consensus earnings for 2013 and a five-year PEG ratio of 0.9.

David Einhorn Greenlight Capital

Billionaire David Einhorn’s Greenlight Capital owned 4.3 million shares of CBS Corporation at the end of June (research more stocks that Greenlight owned). CBS was the #2 holding in JAT Capital Management’s 13F portfolio at the end of the second quarter, with the fund (managed by John Thaler) more than doubling its stake to 7 million shares (see more stock picks from JAT Capital Management). Billionaire Steven Cohen’s SAC Capital Advisors also liked the stock, buying shares on net over the course of the quarter and closing June with 1.9 million shares in its portfolio (find more stocks that SAC has been buying).

Despite their other business interests, Disney and News Corp make good peers for CBS. Disney carries a small premium to CBS, trading at 17 times trailing earnings and 14 times forward earnings estimates. It had low revenue growth in the second quarter versus Q2 2011, but higher margins drove net income 24% higher. We actually think that Disney might merit a larger premium than that; if CBS is underpriced, then perhaps it is as well. News Corp’s forward P/E multiple is 12, which is based on consensus for the fiscal year ending in June 2014. This puts it in about the same value territory as CBS.The company is planning to split in two next year, which has attracted considerable investor interest.

Scripps Networks Interactive, Inc. (NYSE:SNI) operates a number of cable television networks including the Food Network. Scripps Networks is growing well for a TV business, turning in a 13% increase in revenue in the second quarter of 2012 versus a year earlier that drove a near doubling of earnings. Likely due to this growth, it trades at a considerable premium to CBS- at trailing and forward P/E multiples of 20 and 16, respectively. That pricing seems like it would be about right if its growth is modestly higher than CBS’s over the next several years. We’ve also mentioned Comcast and despite its focus on other businesses its ownership of NBC Universal makes it a competitor- such as it is- to CBS. Comcast is also experiencing high growth, with earnings coming in 32% higher in the second quarter compared to the same period in 2011. The size of the company makes this growth rate harder to sustain, though it also justifies the forward P/E multiple of 17.

We think that CBS- as well as possibly Disney and News Corp- are a bit underpriced at current levels. We wouldn’t go so far as to say that CBS merits a trailing P/E of 18 but should see at least some multiple expansion over the next several months, possibly in addition to higher earnings.

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