Analysing the news organisation is a lesson in looking beyond the balance sheet.
The £745 million, national and regional news publisher Reach (LSE:RCH) has seen its stock fall 10% to 215p in response to yesterday’s 2020 results. So, is the investment rationale intact?
Last September, I argued Reach was a ‘buy’ at 75p after its interim results showed this media group – previously Trinity Mirror – performing ahead of expectations. It had a forward price-to-earnings (PE) ratio of just 2x.
Such a low rating relates partly to a £193 million company supporting a £210 million pension deficit, which is an overhang from the plundering debacle of former proprietor Robert Maxwell.
Yet the Express and Star titles had been acquired for £200 million in early 2018 and a string of regional titles also bought in recent years.
It intrigued me how industry values clearly contrasted with a depressed stock value, the price down from 173p in February 2020. Content-wise, I often find Google searches lead me to Reach-owned media, so they must be doing plenty right.
2020 results show reflect continued decline of print
While Covid-19 hit both newspaper distribution and digital advertising in the second half, a 15% decline in overall revenue to £600 million raised a longstanding concern – also behind the low PE. Namely, how digital has to grow fast, and from a low base, to offset the bulk of declining print revenues.
Print is down 19% to £479 million, versus digital up 11% to £118 million, although print too an especially hard 30% hit during the second quarter due to the first Covid-19 lockdown. The narrative speaks of the ‘resilience’ of print revenue, and also how it is a pillar for cash generation to develop digital. That said, overall revenue is down nearly 11% in the first two months of 2020 despite digital advancing over 20%.
A carrot is extended by way of long-term ambition to double digital revenue over the medium term. But, given the extent of stock rally in the last five months, it is hardly surprising momentum traders who previously jumped aboard exited on the news.
A radical contrast in reported and adjusted profit
Normalised operating profit fell 13% to £134 million, which quite leaves open the question of whether digital can replace print. Or at least, sufficiently enough, to further reduce the pension deficit. Otherwise, the situation is in overall long-term decline.
Around £125 million of re-organisation costs are classed as an administrative expense in the income statement, axing reported operating profit to £8 million.
A £5 million pension finance charge and £2.6 million finance costs (a bit oddly given no bank debt, only modest leases) wiped out reported profit, but left net normalised profit at £106 million.
This was actually ahead of consensus for £101 million, even £104 million for 2021, quite illustrating how the bout of profit-taking was significantly newbie traders who did not appreciate the context.
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The £125 million restructuring charge is broken down in note 5 and includes provision for historic phone hacking and property development issues. A relatively modest £36 million was in respect of cost reduction measures, so I doubt an exceptional hit anywhere near this size will recur.
Thus, I think it fair to regard normalised earnings per share (EPS) of around 34p as reflecting the business going forward, which at 218p a share implies a PE of 6.4x. Management appears confident in its strategy “gathering momentum” and an improvement even in the adjusted operating margin this year. Hence, if we can put months of national lockdown behind us then Reach could start to get lucky on the earnings front.
A modest yield, compromised by pension liability
Otherwise, the value equation is pretty mixed, especially for downside protection. A 4.3p dividend in respect of 2020 compares with 2.5p in 2019 but implies an immaterial 2% yield.
Such a pay-out will cost £12 million relative to 2020 gross cash generated from operations falling 18% to £121 million. This was whittled down, however, by £54 million pension funding needs and taxation, to £53 million net inflow from operations.
Financing issues, such as a £19 million deferred consideration payment, £25 million debt repayment and £8 million lease payments, took the net cash gain for the year down to £22 million.
The group’s inherently cash-generative profile – that has eliminated bank debt over the years – means that if Reach’s marketing strategy succeeds then cash may next be prioritised to further reduce the pension deficit.
On, say, a five-year view, Reach could end up as a lean and successful, broadly digital media operation – throwing off cash in support of more substantial payouts.
Reach- financial summary
Year end 27 Dec
|Turnover (£ million)||636||593||713||623||724||703||600|
|Operating margin (%)||15.5||13.9||13.1||15.7||-14.9||18.7||1.3|
|Operating profit (£m)||98.6||82.2||93.5||97.9||-108||132||7.6|
|Net profit (£m)||69.8||77.0||69.5||62.8||-120||94.3||-26.7|
|Reported EPS (p)||27.4||30.0||24.8||22.9||-41.0||31.8||-8.6|
|Normalised EPS (p)||36.1||34.1||34.6||29.9||39.2||41.1||33.6|
|Earnings per share growth (%)||61.4||-5.7||1.5||13.3||31.1||4.8||-18.2|
|Price/earnings multiple (x)||6.5|
|Operating cashflow/share (p)||28.6||20.6||28.2||19.8||12.1||29.0||17.1|
|Free cashflow/share (p)||26.1||19.2||26.7||16.5||8.2||27.8||9.3|
|Dividend per share (p)||3.0||5.2||5.5||5.8||6.1||2.5||4.3|
|Covered by earnings (x)||9.1||5.8||4.5||4.0||-6.7||12.6||7.8|
|Net debt (£m)||16.3||92.2||43.4||9.0||40.8||-20.4||-42.0|
|Net assets/share (p)||231||241||204||235||180||212||182|
Source: historic company REFS and company accounts
Media assets are tricky to quantify
Alongside a currently paltry yield, net assets per share of 182p a share – constituted 151% as intangibles and goodwill – look like less of a cushion too.
There has been a £48 million fixed asset impairment charge due to the closure of two print plants, which will generate annual cost savings of £11 million.
The key question is what values really exist within £819 million intangibles? Legendary investor Warren Buffett used to argue that a strong media franchise was one of the best of all for quality recurring revenues.
But since then, digital space has massively enlarged content that competes for our attention. People live increasingly in their own bubbles. The power once held by national newspapers and the BBC probably continues to decline.
Yet criticism was made of the Mirror effectively being read only by a dying-off generation, only for its digital transformation to become a success. While respecting media values can be mercurial, I remain intrigued at the £200 million paid for The Express and Star.
Ultimately, you only learn what a portfolio of media assets is worth when an industry buyer appears. But if Reach’s continue to evolve well, then do not assume the balance sheet says it all.
Case to hold the stock remains broadly intact
I would give the current CEO more time to bear fruit from his strategy, where the Covid-19 lockdowns have compromised financial delivery. A difficulty is it remaining hard to judge if a firm tipping point has been achieved between declining majority print revenues and surging digital – off a smaller base.
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Online customer registrations are up a remarkable 16%, from 5 million last December to 5.8 million currently.
It is looking good, if hard to truly assess, given it is a tale of two sides and there is a challenge when fathoming complex strands of digital, national and regional media.
Unsurprising then, enough holders opted to lock in gains after a 220% run from last September’s interim results, on a risk management view.
My impression is Reach being quite a favourite new year’s nap in chat forums and other media, while public interest in stocks is also at a high. A consolidation phase looks fair enough, pending progress.
I therefore adjust stance from ‘buy’ without downgrading the company. ‘Hold’.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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