Stockwatch: a share that’s finally got its act together

After a Covid-19 shock, our companies analyst thinks this firm might be in recovery mode.

Shares in national and regional media publisher Reach (LSE:RCH) have been a rollercoaster this year. They’ve soared from about 120p in mid-January to 180p a month later, but were then clobbered by Covid-19 and hardly joined the springtime market rebound. Is it now time to buy?

The share price drifted down to around 50p in August but has enjoyed a near 20% rebound to 75p after first-half 2020 results declared “the company is currently performing ahead of market expectations for the full year”.  

Yes, there was the standard caveat about Covid-19 potentially disrupting the economy again, but the third quarter is already closing – so the rally looks something of a near-term break-out, technically and on fundamentals. 

• What to expect from the stock market in October 2020
• UK banks: material risks and recovery value

The prospective price/earnings (PE) ratio is enticingly a mere 2x, but is explained by a £193 million company supporting a £210 million pension deficit that remains an overhang from the Robert Maxwell plundering debacle. 

Remember, Reach plc was The Mirror owner that changed its name from Trinity Mirror after it acquired more regional titles and, in particular, the Express and Star titles for £200 million in early 2018. That valuation benchmark alone has me intrigued about market value currently.   

The group has shaken off financial critics who said it would go bust and media commentators reckoning The Mirror was finished. Strong cash flow has helped pay down debt and mitigate financial risk, chiefly to the pension fund (whose liabilities continue to reduce under zilch interest rates and as asset prices have risen). I am impressed how The Mirror has been revamped and refreshed digitally, and Google prompts its stories as cutting edge. 

Its equity remains something of a binary proposition. Either a shift to digital media succeeds to more than offset declining print formats, or Reach is in steady decline – its performance tarted up by acquisitions – with the pension load adding to volatility, as if quasi debt. Advertising trends are another key variable, although ad giant WPP Group did say the second quarter of 2020 was a trough. 

Rollercoaster caused by Covid-19

Bear in mind I may have an aspect of bias having drawn attention to Reach as a ‘buy’ since early 2018 at 66p on the basis of a 9% dividend yield and a “scavenger” strategy of buying mature media assets. It reminded me of how various smaller oil & gas companies swelled in value to became mid cap, acquiring North Sea assets being sold by the oil majors. They were, of course, helped by rising oil prices. I have always stressed the crux with Reach is making a success of digital. 

The price breached 180p last February when I moderated stance to ‘hold’, with a sense potentially to buy dips according to underlying progress. Unfortunately, Covid-19 then hit both the stock and business hard. 

• Stockwatch: is this recovery story worth a read?
• What's next after this share doubled in three months?

An April update drew on positives such as cash generation achieving £20.4 million net cash from a net debt position, augmented by a new £65 million bank facility. But it was unsettling how a second quarter update in July cited digital revenue down 15% in context of group revenue down nearly 28%. I did not update my stance as this seemed an exceptional quarter when digital could not realistically be expected to buck the trend. It already looked to be improving in the sense of a 4.9% decline in June versus 22.5% in April.  

Now ahead of market expectations

First-half revenue is down 18% to £290.8 million, with reported operating profit down 55% to £28.9 million. However, it would have been £54.9 million profit excluding provisions. These exceptionals included a £15.5 million contract error on a property conversion related to a former CEO's stewardship, plus legacy claims from the Mirror phone-hacking scandal. 

Interim earnings per share (EPS) was slightly loss-making at the reported level, albeit 14.6p on an adjusted basis. I may be taking a glass half-full view but interim operating profit at more than a quarter of market cap looks a stand-out in Covid-19 times.

Before these results, consensus was for £65.6 million net profit this year with normalised EPS of 28.8p, rising to £92.2 million and 32p in 2021.  

There has been a strong recovery in digital advertising, helped by 3.5 million new customer registrations, with digital revenue growth of 13%. Circulation sales have also stabilised and recovered gradually during the second and third quarters. The cost base has been cut by at least £35 million helping net cash inflow from operations up 14% to £47.9 million. 

Within cash flow dynamics, the contribution from operations rose 11% and pension deficit funding payments eased 10% to £22 million. The overall pension deficit is down 14% to £209.9 million, helped by funding and strong financial markets. Acquisitions cost £19 million.

Performing ahead of market expectations for the full year supports management’s claim about “a strong foundation for the next phase in strategy,” with increased efficiency and agility in advertising and editorial operations.

Balance sheet strength rests on media assets

Management also proclaims “a strong balance sheet with access to sufficient liquidity”. Yes, end-June cash has soared 150% to £66.9 million, although in terms of overall working capital the ratio of current assets to current liabilities is tight at 0.92. This is significantly due to £107.8 million trade payables ahead of £91.9 million trade receivables.  

I think financial risk is minor, despite the stock having an Altman Z1-Score just over 1.0 - as if at serious risk of financial distress in the next two years. This appears chiefly due to the pension fund deficit plus £178.9 million deferred tax liabilities, although in the medium term I think “distress” would need Covid-19 plus a hard Brexit to trash the UK economy. Not to dismiss caution, but this looks an example where credit measures can be backward-looking. Better to examine company details than take your cue from data banks. 

Some would say, however, that £852 million of intangibles/goodwill, comprising 131% of net assets, can never amount to a “strong” balance sheet. Note 12 to the accounts cites this as chiefly publishing rights and titles. Warren Buffett has historically put great store on intangibles’ value - specifically newspapers - as representing his key concept of a consumer “franchise” that is central to investment value. I would not rely completely on this: media is very fast-moving nowadays, where assets can be eclipsed, e.g. The Mirror has needed a thorough revamp to turn its prospects around. But any successful media group will have an intangibles-heavy balance sheet.  

Bonus share issue replaces interim dividend

It revives an old concept of offering a “scrip” dividend choice where shareholders could choose shares or the cash according to their income or capital growth preference. The practice petered out as critics pointed out the cost of creeping dilution. With Reach, there is no choice: an interim scrip dividend will be paid of 2.63p as if conveying 5.2% growth on 2.50p last year, and underlining management’s confidence. A company can “pay out” pretty much what it likes if issuing equity, so I am a tad disappointed the board has opted for this wheeze. 

• Following the collapse in dividends, is growth the new income?
• Do equinoxes really affect stock trends?
• Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)

Even so, barring a worst-case scenario of economic chaos from Covid-19 and a hard Brexit, I think Reach is on a recovery to growth path. It can steadily pay down the pension deficit and the new CEO appears to be carving roles for the Mirror/Express/Star titles backed by a wide stable of regional media.

For example: as a regular searcher of news via Google, also cleaning out my web browser cache, one of the most regular “Accept cookies” requests I get is from Reach plc. That testifies to an ability at getting the titles in the front line of public attention, then capitalising on readers. Trackers do not worry me; they’re a fair trade-off for free stories.  

Reach manifestly has its act together, assuming the economy lets it deliver. At 75p: Buy. 

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