Stockwatch: Is this recovery story worth a read?

by Edmond Jackson from interactive investor |

The headlines for this media stock highlight its recovery progress and improved shareholder returns.

Does a 30% jump from about 63p to 83.5p in the FTSE SmallCap shares of the Mirror and Express media owner Reach (LSE:RCH) suggest the market has twigged a genuine financial future?

The rise has eased to 20% as the price settled back to 76p, showing how patience can be a virtue with stock spikes - while they still reflect a material change in the story.

For some years, what used to be called Trinity Mirror had traded volatile-downwards amid fears that declining print revenues could not effectively be reversed, so despite a strong cash flow profile the business was dying and its stock sustained very low single figure price/earnings multiples.

"Scavenger" strategy starts to get affirmed

Then in early 2018 came a £127 million deal to buy the Express and Star titles, to which I wrote a "speculative buy" piece that February at 66p - suggesting scope to make the assets sweat.

Management had already achieved £15 million synergies from its acquisition of Local World newspapers in late 2015, cut debt, and its "scavenger" approach (my term) to media assets reminded me how years ago, smaller oil exploration and production companies built shareholder value capably - picking off cash generative assets divested by majors in the so-called "dying North Sea".

Companies such as Clyde, Dana and Goal multiplied in value and were eventually acquired for a premium too.  Not an exact parallel but similarities in a contrarian strategy.

I also drew attention to this stock's yield which, given a 6.14p per share dividend in respect of 2018, has turned out at 9.2%. Not all high-yielders are headed for the scrap heap.

Last February's prelims proved better than City forecasts, especially adjusted operating profit up 16.8% to £145.6 million.

The integration of Express and Star was going well, having achieved synergy cost savings of £3 million - with a further £20 million annualised savings targeted by 2020 - while structural cost savings of £20 million had been achieved, £5 million ahead of target. Cover price increases helped revenue and national print advertising trends improve in the second half year.

Financial liabilities have dragged on perception

At the statutory reporting level, however, there was a £107.6 million operating loss reflecting a £200 million non-cash impairment charge, and a further £15.8 million charge after a pension equalisation ruling.

Thus another chief reason this stock has been shunned has been the sense it's effectively a pension fund liability with a company attached: the end-2018 balance sheet showing net retirement benefit obligations of £348.6 million versus market cap of £209 million - even after the share price jump.

There has also been a phone hacking scandal going back to 2011 where investors have suspected liabilities will rumble on, and the 2018 results raised this provision by £12.5 million after utilising £9.6 million with £13.6 million outstanding.

 "Hacked Off", a group representing the victims of phone hacking by the Sun and now-defunct News of the World, along with Mirror Group newspapers, reckons the total bill could reach £1 billion versus nearly £500 million settled to date:

"There are hundreds more claims already underway and many thousands more victims who could potentially claim."

The Mirror has paid out £75 million and says: "We don't believe there would be any merit in spending public money to hold a Leveson 2 inquiry. Practices of the past which gave rise to the original Leveson inquiry have long since been banished from our newsrooms."

Such a stance repeats the government’s line when it shut down Leveson 2 as "no longer appropriate, proportionate, or in the public interest", so it does look as if financial risk is now contained.

More positively, net debt fell by £40.2 million in the second half year alone to £40.8 million, with the total dividend raised 5.9% to show improving financial fundamentals.

Reach - financial summary           Consensus estimates
year ended 30 Dec 2012 2013 2014 2015 2017 2018 2019
               
Turnover (£ million) 706 664 636 593 623 724  
IFRS3 pre-tax profit (£m) 9.7 -161 81.6 67.2 81.9 -120  
Normalised pre-tax profit (£m) 75.6 75 81.3 92.2 123 142 119
Operating margin (%) 13.5 11.3 12.3 14.9 20.0 20.1  
IFRS3 earnings/share (p) 6.7 -39 27.4 29.6 23.0 -41.0  
Normalised earnings/share (p) 23.6 42.5 27.3 39.2 36.1 39.2 38.9
Earnings/share growth (%) -11.2 80.3 -35.8 19.6 -7.9 8.6 -0.1
Price/earnings multiple (x)           1.9 2.0
Annual average historic P/E (x)     4.3 6.0 2.3 2.9 1.9
Cash flow/share (p) 33.9 27.4 34.3 26.7 26.5    
Capex/share (p) 2.2 3.0 2.5 1.4 -2.3    
Dividends per share (p)     3.0 5.2 5.8 6.1 6.0
Yield (%)             7.9
Covered by earnings (x)       6.2 6.2 6.4 5.8
Net tangible assets per share (p) -106 -43.2 -33.4 -77.9 -115 -107  
               
Source: Company REFS              

PE multiple barely 2x, yield testing 8%

The stock continued to trade volatile-sideways until late April when it began rising ahead of the 2 May trading update which pushed the price well over 80p.

Covering the first four months of 2019 it was essentially "in line" rather than guiding expectations higher, although the valuation does look cheap now Reach is managing a way through its liabilities.  The odds will continue to improve if it can deliver "in line" trading updates.
 
Mind how in parallel with Carpetright (LSE:CPR) investors have responded positively to an "improvement" in the like-for-like relative revenue trend despite still being nominally negative: down 6.4% in 2019 versus 7.8% for the first four months of 2018.

Within this, print fell 7.9% while digital grew 8.45% and "a series of digital initiatives are expected to further accelerate this growth." 

The 2018 accounts showed print revenues constituting 79.5% of group total while total digital revenues were 15.4% - i.e. a way to go in terms of rebalancing, and an ongoing risk how consumer recession could hit the group’s chief revenue generator.

But Reach has assets to work with for digital evolution and the chief executive says:

"We continue to make good strategic progress, most importantly with a range of digital projects to drive both page views and revenue, the effects of which we expect to see in the second half of the year."

The inclusion of Express and Star meant 4.4% overall revenue growth and end-April net debt was £22.2 million inclusive of £17.5 million cash after an early repayment of a £20.3 million loan due to be repaid next December.

Are investors warming to recovery plays?

Possibly the stock rise - again like at Carpetright - shows investors more willing to embrace risk in this area of the market. Yet it may also be coincidental how both such recent updates convey businesses improving their stability versus cheap ratings.

Yes, this company's balance sheet continues to show negative net tangible assets, but its liabilities are looking under control. Intangibles of £810million relate to the carrying value of publishing rights/titles, and while that figure could be contested any write-down would be a non-cash matter.

On my frequent test of trade payables versus trade receivables (i.e. is the company settling with its suppliers or delaying on them to push up reported profit?) the two balance in terms of current assets but mind Reach also has £59 million "non-current" trade payables which brings the ratio down to 0.64 overall.

Nothing outrageous though, and which should rebalance longer-term as a next priority after the pension deficit and debt reduction. Strong operational cash flow helps in this respect, e.g. up 29% to £137.8 million. Deferred tax liabilities continue around £160 million but again should be manageable.

Share buybacks as another element of return

Interestingly within the 2018 results statement, a paragraph "Dividends and Share Buyback" cited not only a progressive dividend policy with rises of at least 5% a year but also, if appropriate, the return of capital via a share buyback programme to enhance earnings per share. 

Thus perception is tilting towards this company as being able to generate meaningful shareholder returns: dividends plus a continued if volatile re-rating as risks reduce.  Add.

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

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