UBS downgrades UMG to “neutral,” cites fully priced-in streaming growth

Investing.com -- UBS Global Research has downgraded Universal Music Group (AS:UMG) to "neutral" from "buy," saying the company’s strong start to 2025 and improved streaming outlook are now reflected in its share price.

UMG shares have risen 24% year-to-date in USD, recovering from last year’s Q2 weakness.  The company’s Streaming 2.0 deals with Spotify (NYSE:SPOT) and Amazon (NASDAQ:AMZN), along with accelerating paid streaming volumes, have supported optimism. 

UBS continues to back UMG’s long-term growth trajectory, including its target of a 10%+ compound annual EBITDA growth rate from 2023 to 2028. However, it believes this upside is already captured in the stock’s current valuation.

The downgrade is based on valuation grounds. UMG is trading at a 3.0% estimated free cash flow yield for 2025, comparable to RELX (2.9%) and at a premium to Wolters Kluwer (AS:WLSNc) (3.8%). UBS maintains its 12-month price target of €30, with shares closing at €27.40 on June 24.

The UBS analyst sees potential downside ahead of the second-quarter results due on July 22. 

Despite a slightly lower consensus, UMG is forecast to grow paid streaming by 8% from last year. 

In addition, the company expects weaker free cash flow in the first half of 2025 as well as lower EBITDA margins. 

The delay is due to delayed cash outflows from €1.97 billion in advances committed in 2024, of which only €1.45 billion was recovered.

UBS also cited a decline in cash flow return on investment (CFROI), measured by UBS HOLT, from 17% to 14% in 2024, with further deterioration expected in 2025. 

Key factors include UMG’s continued holding of a 3.2% Spotify stake, lack of dividend income from it, and ongoing M&A activity with limited disclosed returns. 

UMG’s operating leverage remains weak, with just 23% of incremental revenue dropping to reported EBITDA since 2019. 

Adjusted EBITDA to free cash flow conversion was 53% in 2024, below the historical average of 62%.

While a new CFO, Matt Ellis, recently joined the company, UBS does not yet see a shift in capital allocation strategy. 

However, analysts modeled a scenario under which UMG sells its Spotify stake, halts M&A, and focuses on margins. 

This approach, they estimate, would increase CFROI to 22.3% by 2028 and raise the warranted equity value per share to €29.78, about 8% above the current price.

Despite this potential, UBS said there is no indication that management will change course in the near term. For now, it views the stock as fairly valued.