- STW Communications Group reiterates earnings guidance
- Soft outlook sees brokers trim estimates
- Yield and multiple attractive but operating outlook tough

By Chris Shaw

At STW Communications Group's ((SGN)) annual general meeting earlier this week full-year earnings guidance for growth of 5-10% in net profit after tax terms was reiterated. The result now appears likely to come in at the lower end of this guidance range, given a still subdued economy and consumer sentiment.

To reflect the update on guidance, Moelis has trimmed earnings forecasts by 3% annually across the next three years. In earnings per share (EPS) terms, forecasts for Moelis now stand at 11.2c for FY11, 12.3c for FY12 and 13.4c for FY13.

Forecasts elsewhere have similarly been adjusted, Macquarie trimming forecasts by 2-4% through FY12 and RBS Australia lowering numbers by 3-4% through FY13. Consensus EPS forecasts according to the FNArena database now stand at 11.1c for FY11 and 12.6c for FY12.

Despite the cut to its numbers, Moelis suggests there is limited downside risk to earnings for STW Communications given traditional resilience to broader economic conditions. Macquarie is not so sure, taking the view there remains downside earnings risk given a softening industry outlook.

What should also assist with respect to earnings is that STW Communications appears well placed to capture the ongoing shift to digital media. Moelis points out STW Communications should generate 24% of group revenues from digital media this year, up from 17% in FY09. 

The current portfolio should ensure this ongoing shift to digital media is captured by STW Communications as well or better than competitors in the view of Moelis.

While conditions remain tough domestically STW Communications has some growth options, particularly in Asia. As Moelis notes, management have been in discussions with potential partners regarding investment options in the region.

Given the difficult operating environment at present, RBS Australia suggests revised capital management policy of a payout ratio of 60-70% moving forward, up from 60% previously, is conservative. On the plus side, the increase in payouts shouldn't impact on target gearing levels.

Moelis expects solid cash flow generation will allow for debt levels to come down, even allowing for an increase in the payout ratio. As well, there is scope for surplus cash to either be returned to shareholders post the full year result, or for funds to be deployed for bolt-on acquisitions.

Relative to the sector STW Communications offers value according to Credit Suisse, as its numbers suggest the stock is trading on a FY11 earnings multiple of 9.7 times. This compares to the average of the domestic media sector excluding News Corporation ((NWS)) of 16.7 times.

This justifies an Outperform rating in Credit Suisse's view, one that is matched by RBS Australia. As RBS points out, in FY12 the earnings multiple for STW Communications improves further to 9.0 times, while the stock offers an attractive yield of 7.7% fully franked. As with Moelis, RBS Australia sees some scope for capital returns over the next 12 months.

In contrast, both Moelis and Macquarie rate STW Communications as a Hold, Moelis arguing earnings multiples are appropriate relative to the organic growth profile on offer. Macquarie agrees, having downgraded STW Communications to Neutral from Outperform given downside risk to earnings estimates.

The consensus price target for STW Communications according to the FNArena database stands at $1.42, well above Moelis's target of $1.10. The consensus price target implies share price upside of around 30% from current levels.

Shares in STW Communications today are slightly weaker and as at 11.30am the stock was down 0.5c at $1.08. This compares to a trading range over the past year of $0.80 to $1.375. 

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By Chris Shaw

First quarter earnings for WA Newspapers ((WAN)) of $23.5 million were slightly higher than the previous corresponding period but it was a lower result than the market had expected, reflecting a combination of slightly weaker sales and higher than expected costs.

Advertising revenue did nevertheless increase by 7.3% in the quarter, with both real estate and employment classifieds delivering solid increases for the period. This was partly offset by a 2.1% fall in circulation revenues and a large than expected 5% increase in group costs.

Deutsche Bank notes management placed the blame for the result on uncertainty surrounding the proposed Resource Tax and the federal election, as these factors caused advertisers to hold back on spending during the period compared to what had been expected.

Goldman Sachs also saw advertiser uncertainty as the issue, pointing out 1Q sales for WA News of $102.4 million were 5.7% lower than it had forecast. Within this, sales at the flagship “The West Australian” came in 8% below the broker's forecast.

This wasn't the only factor in the view of JP Morgan, as weaker "other" revenue also contributed to the lower than expected result. The main driver of this was a decline in commercial printing revenue following a change in contract structures.

With the election now out of the way a return to more normal conditions is expected from the second quarter of FY11 in the view of UBS. In support of this view the broker notes management has indicated the first two weeks of November saw strong growth in both local and national advertising.

While conditions look set to improve UBS has trimmed its earnings estimates for WA News by 4.5% for FY11 and by 3.5% in FY12, the broker's earnings per share (EPS) forecasts now standing at 49c in FY11 and 55c in FY12.

This is down from 51c and 57 respectively and compares to consensus earnings forecasts for WA News according to the FNArena database of 50c and 55.2c respectively. Despite cuts of 5% and 4.3% to its FY11 and FY12 numbers post the update, Goldman Sachs remains above the market with its EPS forecasts of 53.7c and 63.1c. This reflects an expectation the company will benefit from a strong cyclical tailwind thanks to the strong Western Australian economy.

Credit Suisse retained its FY11 forecast of 50c in EPS terms but notes as some forecasts in the market had been for a result as high as 57c for the full year, some cuts to numbers post the quarterly update are no surprise.

Given cuts to forecasts, including 4.6% and 8.2% reductions to Macquarie's forecasts to EPS estimates of 49.5c and 51.7c respectively, valuation has become something of an issue for WA News. This is particularly the case for Macquarie, as the changes to its numbers mean its target has fallen to $6.96 from $7.52.

The changes to earnings forecasts across the market mean the consensus price target for WA Newspapers has fallen to $7.27, down from closer to $7.50 prior to the trading update.

At a closing share price of a little over $7.00 yesterday, Macquarie estimates WA News is now trading on an earning multiple of 14 times, which is above the market multiple. It also compares unfavourably to multiples for peers such as Fairfax ((FXJ)) and APN News and Media ((APN)) of around 10 times.

To reflect this Macquarie has downgraded to a Neutral rating on WA News from Overweight previously, the only change in rating among those in the FNArena database to cover the stock. The database shows Seven Hold ratings and one Buy. Goldman Sachs also rates the stock as a Buy but is not in the database.

The Buy comes courtesy of JP Morgan and reflects a combination of a 6.6% fully franked dividend yield, double digit earnings growth expectations for both FY11 and FY12 and exposure to the Western Australian economy.

The returns offered by WA News are not enough according to RBS Australia however, who agrees with the Macquarie view the stock is not offering any great value given it is trading at a premium to peers of around 40% at present.

BA-Merrill Lynch offers a similar argument and suggests outperformance in the short-term at least is unlikely given trading over the coming Christmas period is expected to be subdued. With WA News shares trading in line with its revised valuation of around $7.20, down from $7.40, Deutsche Bank agrees any significant outperformance is unlikely.

Shares in WA Newspapers today are weaker and as at 11.30am the stock was down 38c or 5.4% at $6.67. Over the past year the stock has traded in a range of $6.24 to $8.44 and the current share price implies upside of around 7% to the consensus price target in the FNArena database.

By Greg Peel

Seek ((SEK)) shares plunged as much at 8% at one stage in Friday's trade following an out of the blue trading update from management ahead of the company's Annual General Meeting due on November 30. It was not about Seek's core business of online employment classifieds, but about its new businesses in the education sector.

What made the downgrade such a surprise was that previous guidance was of an expectation for “strong growth in revenue and profit” in these divisions in FY11, which was provided only two and a half months ago at Seek's FY10 result release. Education was the star of the FY10 result, contributing 20% of earnings.

Seek was long ago a first mover in offering an online alternative to what had always been a newspaper domain – that of job advertising. Seek has benefited from that first mover status but online classifieds are now de rigeur and newspaper classifieds dwindling. The online market is not yet fully mature and brokers continue to expect an ongoing secular shift, but Seek's success in the field is now at the margin on the ebb and flow of the job ads cycle, rather than in growth from stealing market share from “old media”. It also has competitors.

To that end, Seek has sought to expand its revenue stream by investing in offshore online job ad services, including in China and Brazil, and also by shifting into the education space which it has done through its Learning, Think and IDP divisions. Analysts applauded these moves as providing Seek with new growth opportunities to offset the maturing of the Australian online classified market.

JP Morgan was thus particularly upset by Friday's downgrade from management. “The Education medium term growth outlook was central to our fundamental valuation and positive view on the stock,” the analysts pointed out in their report, and they suggest there are “fundamental and unanswered questions” about a growth story which the company has been promoting over the past year.

JPM believes Seek Education is coming under some competitive pressure and suggests the reasons for the sudden deterioration in Education revenues are “unclear” to both the analysts and management. Strangely, JPM seems rather alone in this view.

While other brokers were caught off guard by the downgrade, and all have made forecast earnings reductions of some 5-10% in FY11, none seem quite as concerned as JP Morgan (who downgraded from Overweight to Neutral on the news). One has to look first at Seek's core business and then at what its expanded businesses represent.

All brokers, including JPM, have offset their Education division earnings downgrades with smaller upgrades to expectations for the local core job ads business. Whether one cites Seek's own employment index, or the ANZ job ads series, or other indicators, BA-Merrill Lynch sums up consensus by suggesting the recovery in job advertising post GFC will continue into FY12-13 as Australia's unemployment rate falls towards 4%.

At the same time, Seek's investments in emerging market online classifieds are expected to start paying off soon with profits being recorded. Zhaopin in China, for example, is expected to reach profitability in FY11. That just leaves Education as the drag.

But is it really a drag?

Macquarie points out there were a couple of one-offs in the Education downgrade, including the closure of the UK business and reaccreditation costs for some courses. But more fundamentally, Credit Suisse sums up the mood by suggesting management's downgrade “gave a more negative impression of [Seek's] earnings prospects than we believe is in fact the case”.

For IDP, it's a matter of countering falling online education revenues in Australia with offshore revenues and higher investment to drive expansion, notes Goldman Sachs and others. Similarly, more investment is being poured into Think to seize future opportunities. In these two businesses it is a case of spending money to provide greater revenue opportunities down the track.

For Learning, it's a different story. The Learning division offers opportunity for those out of work to improve their prospects through education and learning new skills. It stands to reason that this business saw strong revenues in FY10 when unemployment was an issue in Australia. Now that unemployment is ceasing to become an issue, demand for Learning's services have naturally declined.

Several brokers have pointed out that Learning's revenues are thus counter-cyclical to Seek's core job ads business. Through diversification, Seek has reduced the risk of overall revenue volatility rather then providing a mutually exclusive new revenue growth source.

Hence it is wrong to assume, many analysts believe, that the profit downgrade in Education is the death of a Golden Goose, being Seek's new great hope for earnings growth outperformance. Perhaps, however, the market was focusing too much on Education in this light.

Together the FNArena database brokers have reduced the consensus target for Seek to $7.78 from $8.24 as a result of the downgrade. But only JP Morgan has downgraded its rating, leaving a Buy/Hold/Sell ratio of 4/4/0.

As Citi (Hold) sees it, the market was pricing Seek “for perfection” ahead of the downgrade despite inherent risks for new businesses, and now that the market has de-rated the stock it is still well valued. Four brokers, nevertheless, continue to see upside.

The consensus target is 15% above today's trading price.

By Greg Peel

The world was shocked when Rupert Murdoch bought MySpace for US$600m wondering how on earth News Corp ((NWS)) would ever see a return. It wasn't long before MySpace was valued at US$6bn. Then along came Facebook.

Facebook quickly and substantially rendered MySpace almost obsolete, taking social media platforms to a whole new level. Now MySpace is proving a drag on News Corp's earnings and despite relaunching with an updated look and feel this week the site is still an asset Murdoch would like to prevent further losses on.

Maybe an opportunity has arisen.

The speculation in the US at present is that AOL is looking to make a takeover bid for Yahoo! In recent years Google has been to Yahoo as Facebook has been to MySpace. Yahoo's creators were nevertheless roundly criticised a couple of years ago when the company knocked back a pretty good offer from Microsoft. But as Google's dominance becomes more entrenched, perhaps now is time for the two lagging search engines of AOL and Yahoo to join forces.

The press has also raised the possibility of News Corp making an offer for Yahoo.

The analysts at BA-Merrill Lynch reject this notion, suggesting News is more likely to take a strategic stake in Yahoo than an all-out acquisition given the impact on the News' balance sheet and credit rating. However, from a minority position News may well be able to use MySpace as a bargaining chip as it could theoretically, says Merrills, be bolstered by a broader collection of online assets and traffic and advertising potential.

This might ultimately lead to a deconsolidation of MySpace's US$100m-odd drag on News Corp's FY11 earnings, suggests Merrills.

It's only speculation. Merrills retains its Buy rating on News.