By David Randall
NEW YORK (Reuters) - U.S. fund managers' newfound love of media stocks will soon be put to the test.
Shares of Time Warner Inc, Twenty-First Century Fox, and CBS Corp are all up by double digits since the start of the year. That rally came in large part because fund managers jumped in after media stocks tumbled on concerns that customers were increasingly opting for web-based television platforms over cable subscriptions, the type of so-called cord-cutting which has weighed on Walt Disney Co's expensive ESPN sports division.
Now, with media stocks in the S&P 500 trading at a trailing price to earnings ratio of 19.4, their highest valuation in four months, investors will need confirmation that the momentum can continue.
"This earnings season will be an important test for valuations for these stocks," said Steven Cahill, an analyst at RBC Capital Markets. "If it's a quarter where forward numbers have to come down, then all the fears of cord-cutting will be reinforced and these stocks will be stuck in a lower valuation range."
CBS, Twenty-First Century Fox and Time Warner - which are all expected to release their earnings results next week - are the most susceptible to steep drops should their results miss estimates because their forward earnings-per-share estimates have risen since the start of the year, Cahill said.
The number of funds adding shares of Twenty-First Century Fox has jumped 23.5 percent this quarter compared with the quarter before, according to Morningstar data. As a result, its trailing price to earnings ratio has jumped to 25.7, its highest level in more than five years, while its share price is up 14.1 percent.
'STICKY' CUSTOMER BASE
Even with the rally this year, media stocks in the S&P 500 remain 6.3 percent below the all-time high they reached in July. On average, large-cap fund managers have 3.4 percent of their portfolios invested in the sector, down 15 percent from the level a year ago at this time, according to Lipper data.
Robert Burnstein, a portfolio manger at Fairpointe Capital, said that he has been buying shares of Twenty-First Century Fox in large part because its regional sports networks have proven to have a stickier customer base than Disney's national ESPN network, giving potential cord-cutters a reason to keep their subscriptions.
"A local area is much more devoted to their own teams, especially in smaller markets where there is less competition for attention," he said.
Brett Harriss, an analyst at Gabelli & Co, said that the strong bounce back in share prices from earlier this year appears to be over, yet that the sector should continue to improve as more advertising dollars come back to television from digital. He estimates the customer base of networks will decline 1 to 2 percent a year over the next five years as a result of cord-cutting.
"It's going to be a slow decline at worst. There's still a lot of value in a TV bundle," he said.
(Reporting by David Randall. Editing by Rodrigo Campos, Bernard Orr)