Australia | Feb 24 2009
By Andrew Nelson
It’s official, Fairfax Media ((FXJ)) has reported a 1H loss, with falling advertising sales at its newspapers and some pretty big asset write-downs acting as the major culprit. Take out the writedowns and the underlying net result of $157 million met market expectations. Despite the result being pretty much in line with market consensus, stocks were punished, with more attention being paid to the prospects of a future capital raising than the reported financial numbers themselves.
All up, the company booked a $365.3m net loss in the first half, weighed down by $522.9m in one-off charges. Operating earnings declined 11.6% to $370m in the half. The one-off charges included $62.4m in expenses that came from cutting more than 550 jobs since August. Another $447.5m was due to significant write-downs on the value of the group’s mastheads, radio licences and goodwill to account for an increasingly subdued earnings outlook. But large media companies are renowned for carrying a big basket of intangibles, as evidenced by News Corp booking a US$8.4 billion ($12.9 billion) charge on its assets a few weeks back.
Earnings from the group’s metropolitan titles, including The Sydney Morning and The Melbourne Age, slumped 23% to $70 million in the half. The company’s 220 regional and community titles across Australia contributed $102.4m to the result, but were still down 9%, while the on-line plus regional and community publications divisions were the only core business to show any resilience. Regional and community, which is based around the acquired Rural Press businesses, managed to book $102.4m in earnings on revenue of $362 million, while on-line profits rose 13.3% to $56.4m. This includes about $30m from New Zealand site, Trade Me.
CEO Brian McCarthy labelled the outcome as a “creditable trading result under difficult circumstances”. It seems a reasonable claim to be making. The only change in opinion was an upgrade to Hold from Sell by Citi.
That’s all well and good, but it seems what investors really want to know is the answer to the two big questions: when will we see some signs of improving revenues, or at least signs that offer some sort of hope for improving revenues? And more importantly, how much head room does the iconic publisher have before it breaches debt covenants?
Despite management’s constant stream of denials about any need at all to raise cash, $2.5 billion in debt is still a pretty big elephant in the room given the current economic downturn and less than optimistic forecasts for advertising in 2009-10.
The near term outlook means the answer to the first question is; a meaningful earnings recovery is still a way off. Management noted that conditions have worsened in January and February, although they point hopefully to improved display-ad bookings in March. But bookings for classified advertising, which is crucial to earnings, are expected to be weak “at least for the remainder of the financial year”, says McCarthy.
Internet and regional ad flows just aren’t going to be enough to plug the leak in the dyke.
Analysts at Deutsche Bank feel the future of the company is currently poised on a knife edge, with management urgently pursuing cost savings to offset the rapid deterioration in ad markets and stabilise the debt position. On the broker’s current forecasts, the company is just barely flying under its debt covenants in FY10, which makes for a less than appealing investment given the slight margin for error as ad markets continue to rot with no sign of a market bottom. In fact, if the broker’s current FY10 revenue forecasts decline by a further 2.3%, boom, covenants are breached.
It’s no wonder then that Deutsche Bank is the one broker in the FNArena database that has the stock on a Sell, with the target price of 85c post the result also being the most pessimistic of the brokers in FNArena’s universe.
More subdued in its caution is Citi, who maintain a Neutral post the result. The broker notes that current bank covenants allow for some hedging benefits on foreign currency debt, which could see debt levels effectively decreased by $303m. In the broker’s view, this means refinance risk appears the be a bit more muted than some might think. But the risk, admits Citi, is still there. Even though the broker fears a potential equity raising to put the credit rating beyond doubt, the discount to sector valuation is compelling enough to see it upgrade to Hold from Sell.
The other Neutral call in the database comes from BA-Merrill Lynch, who downplays the risk of an imminent equity issue. In fact, it believes FY10 earnings before interest, tax, depreciation and amortisation (EBITDA) would have to fall under $520m for any breach of covenants. This, it feels, is unlikely given the current run of cost savings should underpin at least some moderate security for the next few years. The problem Merrills has is that it believes, regardless of the facts, the stock is likely to find little support in the face of this ever worsening cyclical downturn, which means significant EPS declines in FY09 and FY10 at least.
ABN AMRO Morgans has a similar view on the debt covenant issue, but its analysts are a little less kind in their assessment, believing EBITDA needs to fall below $560m, or more than 33%, to breach covenants. However, this would necessitate a much larger fall in ad revenues than anyone is forecasting. The broker notes net debt was at $2.54bn as at December and it believes this will fall to $2.36bn by June 2009 and $2.24bn by December 2009 on cost savings and asset sales.
UBS has a Buy on the stock and unsurprisingly sees little prospect of an equity raising. Given the broker admits that the earnings outlook is less than rosy over the next few years, it uses the old “attractive relative valuation” argument to justify its positive stance. The broker notes that on its current numbers, the traditional media assets look cheap on a PE of 3x, which also assumes digital assets will trade on 13x, which is in-line with Australian internet peers. UBS expects some sort of revenue led recovery from FY11 onwards, but notes margins will never be the same again.
That last cab on the Buy rank is Credit Suisse, who, out of step with the others, notes stronger than expected revenues at the Australian publishing and printing division and an improvement in working capital management. Still, the broker reduced its forecasts for FY09 through to FY11 as a result of incorporating revised NZD currency assumptions, and after delaying its forecasts for a recovery until 2012. The broker believes the company remains comfortably within its debt covenant limits even after downgrading earnings assumptions.
After dropping more than 3% yesterday in the wake of the result, the dust doesn’t seem to have settled just yet. At 1:00pm today, shares were down another 2.5% to 99c and outpacing broader market declines of 1.5%. Earlier in the day, the price bounced at 93.5c, just above its one year low. Over the last twelve months shares have traded between 93c and $4.14.