Imagine you have bought shares of Sirius XM Holdings Inc. (SIRI, Financial) at the closing price of $5.49 on July 19, and then one day later you see on the news that the stock surged more than 42%, closing at $7.81. This is an ideal scenario for both short-term and long-term investors. However, it also raises the question: Will this rally continue?
I consider that the chances are for a potential reversal as the catalysts behind the rally are not clear and the fundamentals of the company have at least three key warning signs.
Potential reasons for the rally
According to Barron’s, the strong surge was the result of an “apparent combination of short covering, an unwinding of a spread trade involving Liberty SiriusXM and possible buying related to a rebalancing of the Nasdaq 100 Index.”
The shares of the satellite radio company, which offers a subscription-based service providing commercial-free music, sports, news, talk and entertainment channels to its subscribers, have gained nearly 15% in 2023 and around 34% in the past five days.
I would give more credit for the rally to the Nasdaq 100 Index as it prepares for a special rebalance on July 24. The specific details were not disclosed, so this is purely speculative, but a short squeeze typically leads to increased volatility, so do not be surprised if Sirius' stock witnesses a selloff shortly thereafter.
Advantages of its business model
The company has a business model with solid advantages that support revenue growth and high customer retention. One of the primary advantages of Sirius XM's business model is its ability to offer exclusive content that is not available through traditional terrestrial radio or many other streaming services.
It has signed exclusive deals with well-known personalities, artists and sports leagues, providing unique content that attracts subscribers. Sirius XM's satellite-based technology allows it to provide coverage across a vast geographical area, including remote and rural locations where terrestrial radio signals may be weak or unavailable. This gives it a competitive advantage over traditional radio and other streaming services that rely on internet connectivity.
Sirius XM operates on a subscription-based revenue model, which provides a steady and predictable income stream. Subscribers pay a monthly fee for access to the service, providing the company with a stable source of income. Unlike traditional radio, which relies heavily on advertising revenue, Sirius XM's subscription model allows it to offer commercial-free channels or significantly reduce the number of advertisements. This can be appealing to listeners who prefer uninterrupted content.
Sirius XM provides a wide range of content, including music channels covering various genres, live sports, news, talk shows and more. This diversity caters to a broad audience, allowing it to target different demographic groups and interests effectively. The company has established strong partnerships with automotive manufacturers, making their service available as a built-in feature in many vehicles. This integration enhances the convenience for customers and increases the likelihood of new subscriber acquisitions when people purchase or lease new cars.
Further, the company can offer additional premium packages or on-demand content options to existing subscribers, which can increase revenue per user and improve customer retention. Another factor to consider is since it uses satellite technology for broadcasting, Sirius XM's service does not rely heavily on internet bandwidth, making it suitable for use in areas with limited internet access or during peak internet usage times.
Concerns and red flags
The shares trade with a price-earnings ratio of 27.89 and a price-sales ratio of 3.46, which are higher than the industry average. However, the GF Value of $6.95 suggests the stock is fairly valued.
The company has very high ranks for profitability growth and value, resulting in a GF Score of 84 out of 100 that indicates it has good outperformance potential.
While Sirius XM's valuation and fundamentals appear to be reasonable, there are some causes for concern.
First, it is a very high level of debt. Over the past three years, Sirius XM issued $1.4 billion in new debt. The debt-to-equity ratio of is negative, which is a result of negative shareholders' equity.
I have mentioned previously that I do not like companies having negative shareholders' equity. The reason is simple; I pay a lot of attention to valuation, and since equity is the net worth of a company, the higher it is, the better it is for its shareholders to get more value for their investment. A negative shareholder value like for Sirius XM shows that something is very wrong in business performance.
Further, the company displays poor financial strength, having a cash-to-debt ratio of 0.01 as of March, which is too low. A closer look at the liquidity confirms my concerns as the current ratio of 0.35 and quick ratio of 0.35 signal potential financial distress.
GuruFocus aslo shows Sirius XM's operating margin is in a five-year decline. The average rate of decline per year is -5.6%. Further, its revenue growth has slowed down over the past 12 months. Looking at the quarterly revenue growth, I see a momentum problem as the company reported sales growth of 3.06%, 1.20%, 0.13% and -6.09% over the past four consecutive quarters.
Finally, I am not excited about net income growth as, over the past four quarters, Sirius XM reported -5.50%, -15.41%, 47.77%, and -36.16% growth figures.
Sirius XM has several severe warning signs and the latest rally has diminished any margin of safety between the stock price and its GF Value. A lot of caution is recommended as a swift reversal could be on the cards.
