Meet the Street: Waiting for an Ad Spending Recovery

An analyst at David L. Babson makes no bones about the current period, but says not to despair.
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The year 2001 will end up being the worst year ever on record for media companies in terms of advertising revenue, says Ethan Hugo, a managing director at David L. Babson who specializes in media stocks. And next year probably isn't going to be much better, either, Hugo maintains, given the poor condition of the economy.

Ethan Hugo
Managing Director,
David L. Babson

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So why look at

any

of these stocks right now? While it's true that media giants such as

Washington Post

(WPO)

,

Dow Jones

(DJ)

and

New York Times

(NYT) - Get Report

have issued warnings of tremendous losses -- in the Washington Post's case, earnings for the third quarter were down 95% from the year-ago period -- Hugo still believes many of these are good medium- to long-term plays that will rebound quite strongly once the economy recovers.

TSC: What can investors expect from media companies this earnings season?

Hugo: I think the first thing to recognize is that, virtually across the board, earnings will be down year-over-year this quarter. Barring a miracle, that will also be true in the fourth quarter. That tells you what's going on, on a fundamental basis. Companies are, generally speaking, fighting a severe head wind from the economy and, specifically, from the negative currents in the advertising market.

When all is said and done, the environment in the advertising industry looks like it will be the worst year in advertising ever, as long as reasonable data are available. There have only been a few years when advertising in general has been down on a holistic basis for the entire country.

It also looks increasingly likely that in 2002, advertising may also decline, and if that were to be the case, it would be the first time that two consecutive calendar years saw declines in advertising. After an abysmal year in 2001, expectations for advertising growth next year are coming down significantly.

Having said that, media stocks in general, like all stocks, will anticipate future news. Therefore, when there's

any

sign the advertising market could be improving significantly, some of these stocks -- in fact, most of them -- will probably react very positively.

TSC: What is making you think that 2002 is going to be bad as well? Is it just because it's been so bad this year?

Hugo:

It's the economy in general. When consumers aren't going to stores to shop because they aren't feeling wealthy enough to do so, then companies will cut back on advertising because they know they won't be able to bring as many consumers into the stores. Basically,

they batten down the hatches until they can bring the consumers back in. There is only so much that advertising can do to bring the consumers in.

The best indicator of growth in advertising spending is the growth in corporate profits, and right now, the guidance that you get from most companies is that their profit outlook is generally poor, and they really have little information to provide to investors about any profit growth that they might experience next year. In these times of uncertainty, they are not going to commit to spending more on advertising because it's a big part of their cost of doing business. And I think that's true for at least the next couple of quarters.

TSC: Who

is

advertising right now, and which of the various media are getting the advertising revenue?

Hugo:

There really are no broad categories of media where you're seeing increases in advertising spending. On a fundamental basis, I really can't tell you. The numbers really are negative across the board. There are pockets of strength, such as the Hispanic media, but that's a unique circumstance.

TSC: What media companies that you follow seem to have a good long-term strategy that would position themselves well for when the economy returns to its normal growth?

Hugo:

I think

Viacom

(VIA) - Get Report

has a good long-term strategy. They're continuing in their quest to launch niche cable stations. They're pretty well-positioned, and, as well, a significant amount of their revenue comes from the radio and the outdoor markets, which they can package with other media.

I also think

AOL Time Warner

(AOL)

has a good strategy, and I would also say

News Corp.

(NWS) - Get Report

and

Fox Entertainment

(FOX) - Get Report

.

Eventually, it's going to turn around, perhaps by the middle of next year when we get past the poor picture for upfront TV

buying and poor corporate earnings. Once this is over, I think you're going to want to own stocks that have a high degree of advertising exposure.