The year can't end fast enough for Seagram shareho

Seagram's stock (VO) peaked about a year ago at a tad over $45. It's now close to $30. Measured against the U.S. market, the performance looks even worse. Seagram's stock has lost 15% this year, and over the past five years has risen at the leisurely pace of just 6% a year. The S&P 500 index, by contrast, has leaped 30% in 1997 and has posted a 20% annualized return over the past five years.

What's the problem? Seagram's alcohol division, which peddles spirits and wines, has struggled along with the rest of the liquor industry. Particularly in developed markets like the U.S. and Canada, consumers aren't thirsting for the hard stuff.

But Seagram's stock really started to lag the S&P 500 after the company acquired Universal Studios in 1995 for $4.1 billion. It's not so much that the unit has performed badly. But given the volatility of cash flows in the movie-making business, and the heavy investments needed to produce blockbusters, it's a business prone to disappointment. This year, Seagram is paying another $1.7 billion for Viacom's 50% stake in the USA and Sci-Fi cable networks. Since the deal's announcement, Viacom's stock has risen nicely, while Seagram's has sagged. Entertainment has yet to live up to billing for Seagram.

For all its warts, though, Seagram has begun to look attractive. For one thing, expectations are much lower now than a few years ago. In the early 1990s, Seagram, then a beverage company with a big equity stake in DuPont (which it no longer holds), traded for more than 1.5 times sales. Now that it's a beverage company with a big stake in a Hollywood studio, it fetches just one times sales. Other valuation measures also suggest this is a cheap stock. At 1.2 times book value, Seagram is only about one fourth as expensive as the S&P 500, which fetches more than four times book value. Seagram's dividend yield of 2.0% is also 40% higher than the index average, even though the company has boosted its dividends almost as fast as the index average over the past five years: an annualized pace of 9.2% versus 9.7%.

True, Seagram's P/E ratio of 26 is on the high side, especially for a large-cap company that's growing slowly. The company's earnings, however, have been depressed. Seagram earned only 5% on its equity in its latest fiscal year, and its net margin--one of the levers of ROE--was an anemic 4%. There should be room for improvement in both those figures.

For the sake of argument, let's say the glass is half full. If Seagram managed to earn $2.00 a share--granted, analysts are forecasting only $1.46 for fiscal 1999--its P/E would only be in the mid-teens. Such earnings would give Seagram a net profit margin of about 6% and a return on equity of about 8%: hardly a high hurdle.

But that's speculation on my part. In the here and now, Seagram's underlying business has three main attractions:

1) Its beverage unit is a great business. It may not be growing rapidly, but it's very profitable. Seagram's beverage division only brought in 55% of the company's sales in the latest quarter, but 77% of its operating profits. Besides spirits and wine, Seagram makes juices: Its Tropicana brand enjoys a huge market share in the North American juice industry.

2) Seagram is strong overseas. In its latest fiscal year, Seagram generated 58% of its operating profits from Europe. Another 9% came from Asia/Pacific and Latin America. While the developed world may have all the liquor it wants, demand is strong--taking into account bumps like the recent turbulence in Southeast Asia--in the developing world. Juice sales, too, are growing nicely overseas.

3) Seagram is financially sound. The company's financial-leverage ratio--the ratio of the company's assets to its equity--is 2.9. In itself, that figure means little. It's about average for companies the size of Seagram. But considering that Seagram is in the entertainment business, a volatile area in which debt can considerably weaken a firm's ability to compete, it's a key figure. With more than half of its sales coming from the steady beverage industry, and with an average assets/equity ratio, Seagram is in great financial shape. That means it has the resources to invest heavily in both entertainment and beverages, boost dividends, and buy back stock. In fact, the company is doing all three.

So Seagram has several fundamental strengths. Combine those with a cheap stock--cheap both relative to its own historical levels and relative to the S&P 500 index--and Seagram really starts to look interesting. If the company can shore up profits in the U.S., both in the entertainment and the beverage units (but mostly the former), the stock would almost certainly be a great long-term performer. If it doesn't shore up those profits, the stock should still be a decent performer; as we've seen, expectations are low. Anyone looking for a cheap large-cap stock--and one that isn't a cyclical--should find in Seagram a good choice.