Stockwatch: A cheap recovery stock with 7% yield

After a long and painful demise, this share is one of 2019’s big winners. Should you stick with it? 

Low valuation and high yield can foreshadow trouble, yet some fallen stocks also deliver excellent gains as the company de-risks.  

Worth around £290 million and currently trading at 94p, Reach (LSE:RCH) is the relatively new name for Trinity Mirror – a situation once derided by media experts for having no future at all.  

The Mirror newspaper was said to be read by a dying breed of old traditionalists, and that it had no real digital following. It was also tarnished by the phone hacking scandal, and the company came with a whopping pension fund liability courtesy of the Maxwell looting episode.

Parallel with “recovery to growth” situations in oil & gas?

Yet a strong cashflow profile from print operations intrigued me, as it did nearly two decades ago when smaller oil & gas exploration/production stocks were shunned because the North Sea was similarly in decline – some said a graveyard.  

Then, you could buy stocks such as Clyde, Dana and Goal at a discount to the cashflow valuation assets with the entire exploration side (often attractive international) abroad. The companies prospered as cashflow was re-invested and they ended up being taken over at 10x to 20x their year 2000 lows.

So, despite falling print revenues I was interested whether new management at Trinity Mirror could get a grip and, quite similarly, apply cashflow for digital growth. Similarly, as small exploration and production stocks grew to become mid-caps, “scavenging” for cash generative assets, perhaps the same could happen in newspapers?  

Having hit stock highs around 700p in the early noughties, Trinity Mirror collapsed to below 30p in 2012 and bumped along. It bowled a googly by way of appointing Simon Fox as CEO from HMV Group, where I felt Fox’s radical acquisitions (at least one out of administration) contributed to its woes, as it struggled to sell entertainment via the high street while digital sites prospered.  

Financial progress tips risk/reward equation positively

But I was convinced enough to suggest “buy” at 66p in early 2018 given the way Fox had exacted £15 million of savings, was cutting debt and seemingly engaging a “scavenger” approach – buying the Express and Star newspapers. Given a 6.14p dividend, the 2018 yield turned out at 9.2%. This extent of yield does not automatically flag danger and I suggested continuing to buy at 83.5p last May.

Source: TradingView Past performance is not a guide to future performance

If consensus forecasts are fair, then a 6.41p payout in respect of 2019 and 6.74p for 2020 means early 2018 buyers locked into a double-digit yield that’s covered 5-6 times by earnings, or a 7% yield now. 

Last July’s interim statement showed cashflow rising 16% year on year to £70.4 million – pretty remarkable for six months by a small cap. It reported £6 million of acquisition synergies recently delivered, and Reach is on target to deliver at least £15 million annualised savings altogether in 2019 and £22 million in 2020, beating previous guidance for £20 million. Also, £5 million of structural cost savings are already achieved, and it should do double that for the full year.

So, while I’d remain cautious about exactly how successful the Mirror, Express and Star titles can prove, bolstered by digital revamp, underlying financial progress tips Reach’s risk/reward profile to steady upside. 

At 95p, its forward price/earnings (PE) ratio is sub 3x and prospective yield is 7%, reflecting a continued modest decline in overall revenues. Yet the company has eliminated debt, is managing its pension liabilities and is throwing off enough cash to raise its interim dividend by 5.5%.  

“Steady Eddie” end-November trading update

On 29 November, with specific regard to July to November, Reach cited an “improvement” in its trend of revenue decline: 4.4% down versus 6.6% for the like-for-like 2018 period. Print fell by 7.3% while digital grew by 14% versus an 8.2% fall and 9.3% rise respectively, like-for-like.  

Crucial for perception of the stock is whether this balance reaches a positive tipping point. As a result of digital initiatives “we remain encouraged by strong audience growth across our portfolio of national and regional sites,” it said, and at least seven new “live” launches are planned for 2020.

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Meanwhile, cashflow has remained sufficiently strong that a net positive cash balance is indicated for the year end. The trend has seen net debt (i.e. subtracting cash) reduce from £109.8 million at end-2015 to £40.8 million at end-2018 and £12.9 million last June. 

Mind other balance sheet liabilities where the last interim statement cited a £348.2 million pension deficit under IAS 19 accounting, although cash generation is enabled Reach to meet a £24.5 million contribution in the first half, in context of £48.9 million a year for 2019 and 2020.  Undoubtedly, it’s a drain but Reach is managing through.  

There was also £159.6 million of deferred tax bumping up total liabilities to £767.5 million at end-June, in context of £578.2 million net assets, albeit swollen by £810 million intangible assets and £42 million of goodwill.  

Media assets justifiably include intangibles, although I’d benchmark value in the cash they generate. Negative net tangible assets will deter conservative investors although, with debt eliminated, the chief liability to service is left at the pension fund.  

Yes, it’s still rather messy but unless the UK economy lurches down – to impact advertising hence media revenues – Reach is progressively being tidied up at a time when its rating remains cautious.

New broom CFO and CEO added to the equation

Simon Fuller took over as finance director last March with a background at McColl’s Retail and Tesco (LSE:TSCO). That doesn’t exactly wow me, given McColl’s fallen profits and accounting controversies over Tesco, if hard to ascribe to an individual. In context with Jim Mullen taking the reigns as CEO last August, it at least provides fresh perspective at the top which is no bad thing.

Mullen was previously CEO at Ladbroke Coral before its £4 billion takeover by GVC Holdings (LSE:GVC) two years ago; and, while I recall Ladbrokes being a somewhat flighty situation, it was clearly good enough to attract a buyer. As for media experience Mullen has been a director of product management and digital strategy at News International following 11 years in advertising. So, he looks well-suited to Reach’s challenges.

Fox claimed it was appropriate to leave given the integration of the Express and Star had been successfully completed, digital growth was accelerating, and the group’s trading/cash position was strong.

In the latest update Mullen says he’s “impressed by the strength of Reach’s national and regional brands, the quality of our content and the wide geographic distribution of our products through both print and digital channels.”  

That appears a tad rose-tinted given continued decline in print however, he adds, “we are working to complement our audience reach with a significant depth of customer insight and data that will allow us to build an intelligent, relevant and trusted content business for the long term.”  

Ultimately, it’s a question whether digital can prevail 

So, there remains an aspect of speculation here: investment value, yes, in Reach’s cashflow streams, but revenue streams will need to tip positively in due course, otherwise a sense will persist that Reach is sweating assets for cash to meet its pension liabilities.  

The dividend payout is attractive but would be compromised if the media titles fade. Mullen must continue growing the digital side and create new dimensions for it. 

The stock leapt 15% from 83.5p prior to the end-November trading update, as if sentiment is turning, although it had previously fallen from a low 90p range, possibly as investors remain wary. I view that positively: the stock can rise with underlying progress as Reach “climbs a wall of worry”, quelling fears.  Management has affirmed expectations for the year and consensus I’ve seen is for net profit around £115 million, hence earnings per share of 39p and a prospective PE multiple of just 2.6x at 94p currently.

In a hung parliament scenario - which would be very much “risk off” small cap and UK domestic assets – then, in the short term, Reach probably couldn’t fight against the tide. However, a Boris majority would likely see its stock rise. Broadly, my view of Reach would be: Hold.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.