Warren Buffett has been selling out of a lot of stocks recently, cutting back significantly on his largest holdings and raising cash in a somewhat ominous sign.
But Buffett's conglomerate Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B) hasn't only been selling stocks; it has also been buying or adding to a few select holdings.
One is Sirius XM Holdings(NASDAQ: SIRI). While Berkshire has owned the Liberty Media tracking stock since 2016, which tracked Liberty's large stake in Sirius, Berkshire has increased its bet on the satellite radio operator this year, ahead of the tracking stock's merger with publicly traded Sirius shares in a simplification merger in September.
Berkshire disclosed it owned 105.2 million shares of Sirius at the time of the September merger, up from 101 million at the end of June. Then last week, Berkshire disclosed it had increased that stake to 108.7 million shares between October 9 and 11, good for about 32% of the entire company.
Sirius' stock is down some 48% on the year, but here is why Buffett and his team may see opportunity.
Sirius stability
One aspect of virtually all stocks Buffett owns is a degree of stability in its results. Sirius is a subscription-based satellite radio platform. In 2019, the company bought Pandora Radio, which comes in both subscription and free ad-supported formats. But last quarter revealed that over 76% of Sirius' total revenue came from subscriptions.
Recurring subscription businesses tend to be relatively stable. Additionally, many automakers install free trials of Sirius XM in new vehicles, which is a highly efficient method of customer acquisition.
Finally, Sirius' churn has historically been low. Although the company has seen mild subscriber losses this year -- more on this later -- the company's self-paid churn figures have been very stable, between 1.5% and 1.8% every quarter going back five years. So, this year's mild losses are more due to weaker new customer acquisition, rather than loyal customers abandoning Sirius' platform.
The relative stability of Sirius' revenue and profits is an essential component to Buffett's long-term investing philosophy.
Cash flows and returns to shareholders
Another attribute Buffett likes is high and stable margins, with companies that seek to improve those margins continuously. On that note, Sirius' Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) margins have consistently ranged between 29% and 33% on a quarterly basis, which is pretty high, over the past five years.
While growth has slowed and Sirius' top-line has declined a bit this year, the company has also been able to cut $50 million in costs through an optimization program. Last quarter, Sirius was able to cut 17% in engineering costs and 23% in general and administrative costs, bolstering margins even as revenue declined.
The company does a good job of turning that profit into free cash flow, which it usually uses to repurchase stock and pay dividends. Currently, Sirius' dividend yield is a healthy 3.9%.
Although Sirius' repurchases stopped over the past three quarters, that had to do with the SEC rules ahead of the simplification merger. In September, after the merger was completed, Sirius reauthorized its $1.17 billion repurchase program. While we don't know whether Sirius is again repurchasing stock, there is a high likelihood it is, especially at these prices.
Image source: Getty Images.
A bargain valuation
Another reason Berkshire is increasing its stake in Sirius is that the equity is quite cheap. Currently, shares trade at just 8.3 times earnings.
The reason for the current valuation is the pessimism over Sirius' growth. Like many streaming or "stay-at-home" stocks, Sirius saw pretty strong growth during the pandemic, but the hangover of high interest rates and inflation have apparently caused consumers to pull back on discretionary purchases. Additionally, auto sales have slowed markedly since mid-2023, with pre-installed Sirius trials in cars being a large part of how Sirius acquires new customers.
So, the big question is, is the dip in subscribers a harbinger of things to come? Or is it just a temporary slowdown reflecting an automotive down-cycle following the strong Covid period?
Clearly, Buffett and his team think it's the latter. And with interest rates and inflation starting to come down, the auto industry could eventually see a pickup in 2025, potentially taking Sirius's growth up with it.
Risks to the thesis
Of course, there is a reason Sirius has traded down to the valuation it's at today. Only eight out of 18 Wall Street analysts rate the stock a "buy," largely due to these growth concerns. Additionally, while Sirius' equity is cheap, it does have a considerable amount of debt, at just over $9 billion -- nearly as much as Sirius' $9.2 billion market cap.
That debt is currently around 3.2 times Sirius' EBITDA, within management's guided debt ratio in the low-to-mid threes. Sirius feels comfortable with that debt ratio given its relatively stable cash-generation. However, if results were to significantly deteriorate, the debt could turn into a problem.
Still, it's clear Berkshire believes results will stabilize and improve, and that management will continue its leveraged cash returns to shareholders in a value-accretive way. Given Berkshire's recent purchases, it appears Buffett and his team likes Sirius' valuation very much at the current stock price.
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Billy Duberstein and/or his clients have positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
