Australia | Feb 03 2009
By Greg Peel
One would be hard pressed to find a broker who could come up with any good reason to own media stocks at present. As each quarter has ticked by over 2008 and global economic warnings become more and more dire, analysts have continuously downgraded their forecasts for advertising spending. This is the case at the retail advertising end and at the job advertising end as unemployment begins to rise.
A year ago Fairfax Media ((FXJ)) was being praised for having diversified sensibly away from simple, albeit iconic, metro mastheads and expanded into the digital realm as well as other traditional media forms. However, the state of the economy ahead was not known at that point, and now analysts are hard pressed to find anything good to say.
Given its expansion program involved plenty of debt financing, Fairfax became a problem from the other side of the balance sheet. Last November, ratings agency Standard & Poor’s confirmed the company’s BBB- rating and indeed suggested Fairfax was at the high end of expectations for such a rating, but warned “the rating may fall if Fairfax does not respond appropriately to emerging earnings pressure in 2009 and beyond”.
One can only assume that “earnings pressure” seems even more real three months later.
The analysts at Citi have recalled S&P’s warning in a report this morning. While praising the company for offloading the non-core television production house Southern Star, and cutting the dividend payout ratio to 20%, Citi calculates that Fairfax’s debt/earnings ratio will breach S&P’s requirements in FY09. S&P needs to see a debt over EBITDA level under about 3.5x, yet Citi forecasts an FY09 ratio of 3.8x, rising to 4.1x in FY10 under current economic conditions.
What to do?
Citi suggests Fairfax has three options. Firstly – grin and bear it. Continue with restructuring but risk a credit rating reduction to “junk” status. A junk rating is simply no rating. If your balance sheet does not meet reasonable criteria then the S&Ps of the world aren’t interested in wasting their time analysing you. This means potential lenders (investors in Fairfax paper) have no benchmark with which to measure insolvency risk and so either shy away or increase required lending rates substantially. Most mutual funds are not allowed to invest in unrated paper and may be forced to divest.
Secondly, Fairfax could continue selling supposed non-core assets such as, Citi suggests, its radio assets. Yet in so doing Fairfax faces the same problem so many companies in any sector have in front of them at present – sell all your assets at the bottom of the cycle and then miss out on recovering revenues on the way back.
Citi thinks the third option is the most likely – raise fresh equity. The analysts calculate Fairfax needs something in the order of $600m. Shareholders be warned – that would dilute FY10 earnings by 15%.
Citi is sticking to a Sell rating on Fairfax given the combination of earnings risk downside, gearing issues and potential dilution.
That leaves Fairfax with a 4/3/2 B/H/S ratio in the FNArena database, meaning not all analysts share Citi’s downbeat view. However the Southern Star divestment had a few of them perked up, so ongoing economic weakness may yet bring some changes of heart. The average target is nevertheless $1.99 (Citi $1.15) against this morning’s share price of $1.27.