Advertisement Lamar (NASDAQ: LAMR) is a silent and almost unsuspecting outperformer who benefits from inflation and several industry-related secular trends.
Lamar Advertising is one of the largest outdoor advertising companies in the United States. Lamar operates three segments:
- Advertisement signage : Leased advertising displays located near major highways, traffic arteries and city streets. Billboards consist of large light structures (newsletters) or smaller structures (posters). Lamar operates approximately 153,800 billboards. While most billboards are static, Lamar operates 3,932 digital billboards in Q4 2021.
- Logo signs: Leased advertising space located near exit highways such as advertisements for gasoline, food, camping, lodging, etc. Lamar operates approximately 137,800 logo stores.
- Transit advertising displays: Advertising space rented outside and inside transit vehicles, air terminals, bus shelters and benches. Lamar operates approximately 46,600 transit displays.
More than 90% of Lamar’s revenue comes from the billboard segment. The land underlying Lamar’s billboards is owned or leased by the company and the billboards themselves are leased for terms ranging from 4 to 52 weeks.
The outdoor advertising industry is fragmented, with Clear Channel (CCO) Outfront Media (OUT) and Lamar Advertising holding 15%, 20% and 25% market share respectively (Billboard REITs: In Your Face, But Under Le radar). The remaining market share belongs to thousands of small owners (ibid.). Thus, the big three outdoor advertising companies are consistent acquirers of the smaller players.
Outdoor advertising is heavily regulated by federal law which controls outdoor advertising along federal highways. In addition, all states have billboard control laws and regulations at least as restrictive as the federal requirements. In some cases, states have passed laws that require the removal of signs at the owner’s expense without compensation from the state. However, management believes that the number of billboards subject to removal is illegal and immaterial and that no state has banned billboards outright. Additionally, billboards were sometimes removed for beautification purposes under the power of eminent domain, but Lamar generally received compensation for the removal of these billboards. Due to the strict regulations around new billboards, many existing billboards are grandfathered and quite insulated from new competition.
Another factor impacting Lamar’s business is the growth of digital billboards. Digital billboards are essentially like a large television screen that changes advertisements every 6-8 seconds. Although installation costs are higher, digital billboards have a more attractive economy because they allow Lamar to sell advertising space to multiple customers (compared to a static billboard) and easily edit content inexpensively. Lamar has 3,932 digital units at the end of Q4 2021 and plans to continue growing its digital footprint where regulations allow.
Regulations limiting new billboards reduce the threat of entrants and new competitors and give Lamar pricing power over its existing billboards. Additionally, the growth of digital billboards provides an opportunity for margin expansion due to more attractive economics compared to static billboards. The lack of new competition combined with the short duration of publicity creates a perfect storm that allows Lamar to benefit from an inflationary environment. In fact, management’s commentary on the Q4 2021 conference call sums up some of the secular trends that Lamar is experiencing:
Interestingly, even in light of the additional capacity, our same unit digital yield increased 16% in the fourth quarter and 23% for the full year of 2021. So clearly we have pricing power with our digital unit. But one of the best stats we’ve seen in Q4 2021 is for our analog displays. Our rate increased by 5% and our most important product, the Bulletin rate, increased by 6.6% in the fourth quarter. Again, this gives us enormous confidence, first, that in an inflationary environment, we have pricing power. And second, again, as our Transit and Airport divisions continue their recovery, we should see outsized growth across the platform in 2022.
Considering these facts above, it’s no surprise that Lamar performed well. Compound annual returns for Lamar were 17.28% per year from 2017 to 2021 and 20% per year from 2012 to 2021. Having owned Lamar for over five years, I decided to assess where it stands.
To value Lamar, I used a discounted cash flow model to account for recovery from the effects of the COVID-19 pandemic. Since many REITs use FFO or AFFO as measures of cash flow, I decided to start with AFFO and make adjustments to calculate free cash flow to equity. AFFO is a cash flow at the equity level, which means that it already includes payments to creditors (interest payments, not principal payments) and maintenance investments. Lamar is an attractive business from an investment perspective, as existing billboards require little future investment.
Lamar reported AFFOs of $667,744 for 2021 ($6.49 per share) and management indicated in its 2022 guidance that it expects to report AFFOs of $7.18 to $7.30 per share. This represents nearly 9% growth in AFFOs compared to 2021. These forecasts do not reflect any impact from acquisitions. After 2022, I estimated that the AFFO would increase by 5% in 2023 and 3% in the long-term terminal period. The 5% is somewhat arbitrary, but I’m down to 9% growth and a bit above inflation estimates of 3.4%. From AFFO, I made the following adjustments to derive free cash flow to equity:
- Debt change: Added cash inflow from the impact of new debt issuance at the same pace as AFFO growth rates. This keeps Lamar’s capital structure constant at current levels. Lamar’s debt levels are conservative and he boasts the healthiest balance sheet in the industry with a debt-to-MVIC ratio of around 20%.
- Change in NWC: Estimate changes in working capital by increasing working capital at AFFO growth rates.
- Stock-based compensation: Subtract stock-based compensation that has increased at AFFO growth rates from 2021 levels. Stock-based compensation is a reinstatement for purposes of calculating AFFO.
A final adjustment to cash flow is not straightforward, and that is taxes. REITs avoid corporate tax by distributing nearly all of their income as dividends. Therefore, the value of Lamar (and other REITs) may differ depending on an individual’s tax bracket. To account for this, I have prepared a valuation matrix with different discount rates and tax brackets so that investors can consider Lamar’s value to them based on their tax bracket. Taxes have been calculated assuming full payment of AFFOs in the form of dividends. In addition, the tax rates used did not take into account Section 199A dividends which provide for a 20% deduction. It’s important to note that nearly all of Lamar’s recent dividends have been classified as Section 199A dividends, so taxes may be slightly overstated. The example below uses a C-Corp as-if rate of 21%.
The above estimates resulted in the following cash flows.
|AFFO||726 137||762,444||785 317|
|Add: Modification of the debt||271 224||164 241||103,472|
|Less: Chg. in the NOC||(36,342)||(6,819)||(4,296)|
|Free Cash Flow to Equity||920 288||877 098||840 442|
|Taxes at 21% (as if C-Corp)||(152,489)||(160,113)||(164,917)|
|Free cash flow after tax||767 799||716,985||675 526|
|PV of cash flow||710 925||614 699|
For a discount rate, I have included discount rates ranging from 7% to 10%. The example above uses a discount rate of 8% which I believe is a reasonable upward adjustment to the market rate of return of about 7% given Lamar’s sensitivity to economic downturns.
|PV of cash flow||1,325,624||Terminal cash flow||675,526|
|PV of the terminal value||11,583,086||Capitalization rate||5.00%|
|Equity value||12,908,710||Net value||13,510,512|
|Share.||101 133||HP Factor||0.85734|
|Price per share||$127.64||PV of the terminal value||11,583,086|
The following shows the matrix based on different tax rates and rates of return.
A weakness in my forecast is that it increases the growth rate to 3% by 2024. While this growth rate should be lower than what Lamar can actually report since only maintenance investments have been deducted in AFFO (thus excluding growth investments and acquisitions), actual organic growth may differ from my forecast. Additionally, the forecast does not include any potential margin improvement. As a result, I view my forecasts as fairly conservative and remain positive on Lamar given the company’s secular trends. Simply put, I don’t think I’d be surprised if Lamar did better than I expected.
In summary, Lamar continues to benefit from favorable industry trends and is insulated from both competition and an inflationary environment. I would consider buying or adding to Lamar at these levels as a long term investment. Also, if you are in a lower tax bracket or have a tax-efficient account such as an IRA or 401k, Lamar should definitely be considered in your portfolio.