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By Bill Trent
RealMoney.com Contributor
2/21/2008 11:59 AM EST
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The last year hasn't been a good time to own a newspaper.
The best-performing stock was
The Washington Post Co.
(WPO)
, which managed to not decline significantly.
The New York Times Co.
(NYT)
and
Gannett
(GCI)
are down as much as half, while smaller firms such as
Lee Enterprises
(LEE)
,
Belo
(BLC)
,
McClatchy
(MNI)
and
Journal Register
(JRC)
have registered declines ranging from 60% to 80%.
Always on the eye for a contrarian opportunity, I wondered if the time might be right to take a stake in one of the papers. The one that most attracts my eye is Lee. Lee provides local news, information and advertising in primarily midsize markets, with 50 daily newspapers and a joint interest in five others, rapidly growing online sites and more than 300 weekly newspapers and specialty publications in 23 states. In 2005, the company acquired Pulitzer, and it has since trimmed the combined operations by selling certain local papers and printing operations.
Although its valuation multiples and price performance resemble those of the other small firms, Lee is less heavily leveraged (a mere 3:1 debt-to-market-cap ratio compared with 4:1 at McClatchy and 12:1 at Journal Register) and generates a significantly higher free cash flow yield than those firms. Compared with Belo, its Zacks rank of 2 indicates favorable earnings revisions, while Belo is in the worst category.
However, it will take more than being the best in a rotten bunch for me to take the plunge. Lee has to offer some real value and pay me for the risk I would be taking by owning the name. At first glance, the 10% free cash flow yield (operating cash flow plus after-tax interest expense minus capital expenditures, divided by enterprise value) and 6.4% dividend yield would appear to do the trick. But are they sustainable?
There doesn't appear to be much near-term risk to the dividend because of its relatively small share of annual cash flows. The company's pension plan is under-funded by $75 million, but the annual required contributions are just a few million.
The biggest concern relates to $306 million in notes issued in conjunction with the Pulitzer acquisition, which are due in April 2009. It would be tough to come up with that money in the current credit environment, but at some point over the next year I expect the credit markets to return to normal. Under its credit agreements, Lee can also increase its line of credit by up to $500 million as long as it meets certain financial criteria.
The Best-Laid Plans
Over the longer term, Lee will have to generate at least modest revenue growth (the consensus five-year estimate is 5%) and execute according to its plan. Unfortunately, the plan is running into some roadblocks.
| Lee Enterprises' Stated Corporate Plan |
| Plan |
Reality |
| Grow revenue creatively and rapidly |
In the latest quarter, revenues declined 6.2% compared to the prior year |
| Deliver strong local news and information |
Presumably going according to plan |
| Accelerate online innovation |
Online ad revenue was sufficient to offset declines in print advertising in FY 2007, but in the December quarter it was not |
| Continue expanding audiences |
Average daily newspaper circulation units decreased 2.0% and Sunday circulation decreased 2.5% for the 13 weeks ended December 30, 2007, compared to the prior year |
| Nurture employee development and achievement |
In 2007, the St. Louis Post-Dispatch concluded an offering of early retirement incentives that resulted in an adjustment of staffing levels |
| Exercise careful cost control |
Costs were cut by 4.9%, but revenue fell at a faster rate |
| Source: Company filings |
Earnings Quality
Until management can effectively put its plan into action, revenue and earnings look set for continued declines. In 2007, operating income decreased $5,157,000, or 2.5%. Tax settlements reduced income tax expense by $6,880,000 in 2007. On an apples-to-apples basis, earnings per share declined from $1.82 to $1.66.
While the earnings are declining, they do appear trustworthy. The accrual ratio measures the difference between cash-based earnings and accounting (accrual) based earnings. The closer to zero, the better. With the exception of a spike in 2005 related to the Pulitzer acquisition, Lee's earnings quality has been high.
Enhance Yield With Options
Although a put-write may offer another alternative play on the name, the options are thinly traded. The March 12.50 puts are available for about $1.45 at the time of writing, while the March 10s are trading at about 30 cents. The choice would depend upon the investor's objective: Someone wanting to own the shares at a lower price could use the $12.50s to get an effective purchase price of just over $11.00, while an investor who doesn't really want the shares could get a 3% one-month yield on money at risk using the 10s.
I also believe that if I wrote put options and ended up with the shares, I would turn around and write covered calls to continue enhancing the yield and offsetting some of the risk.
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