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Read the headlines, skip the stocks
With a couple of exceptions, newspaper stocks are too expensive in an ad market that's seeking more finely targeted audiences.
By Robert Walberg
During the Democratic convention last week, Theresa Heinz Kerry created a hullabaloo when she told a reporter to shove it. But theres one place in which her sentiments are shared, and thats on Wall Street.
Media companies have fallen on hard times in recent months, disappointing investors who were expecting a strong, sustained recovery. Investors have been voicing their displeasure with the group by taking many of the stocks to new 52-week lows.
Starting with the newspaper publishing group, well spend the next couple of weeks examining the media sector to determine whats behind the poor performance and if now represents a good entry point for long-term investors.
When the year began, the investment community expected the recovery in the domestic economy to lift advertising revenues and propel newspaper publishing earnings sharply higher. Despite the sentiments expressed by Teresa Kerry, the presidential election was also supposed to be a supporting factor for the group, as political candidates were expected to spend record sums on advertising. Though earnings in the group are seen rising by an average of 17% in fiscal year 2004, the gain is coming less from an industrywide jump in ad sales than from a continued push to streamline operations.
Newspaper publishers have cited several reasons for the lackluster advertising, including weaker-than-expected spending from technology companies and general reluctance to commit to spending from the big national players. However, one problem with this argument is that ad spending in other media -- especially online -- is booming. Yahoo! (YHOO, news, msgs), for example, posted a big jump in second-quarter earnings due in part to a considerable rise in ad revenues. Even within the industry itself, there are mixed signals. The New York Times Co. (NYT, news, msgs) saw ad revenue at its newspapers jump by a meager 1.7% in the last quarter. But ad sales jumped nearly 27% at its Internet properties.
Marketers see increasing options
In other words, the problem might not be temporary but structural as marketers increasingly shift toward other, more focused, outlets to reach their target audiences. Cable television, the Internet and cell phones all represent serious competition to a newspaper publishing industry that many see as old school. Not only do newspaper companies generally reach less-defined audiences, its tough to track the success rate of an ad on its target market. On these fronts, newer, more targeted media outlets, have the upper hand -- which helps to explain why marketers are shifting their spending.
Put simply, marketers have a wider array of options to reach their audience, and they are increasingly using these more dynamic alternatives to augment, if not replace, more static newspaper ads. Regardless of the economys underlying strength or how much politicians spend on their campaigns, newspaper publishers face a changing advertising landscape thats giving long-term concern among investors.
Thats not to say that there arent pockets of strength, such as with the smaller, more local outfits. Strong ad sales helped the Journal Register Co. (JRC, news, msgs), which operates 23 daily newspapers and 237 non-daily publications, meet consensus estimates in the most recent quarter. But most of that growth came from classified ads, particularly job and real estate postings. Retail and national advertising remains spotty throughout the group, and, based on the recent spat of cautionary guidance from industry execs, investors can expect more of the same for the balance of the year.
With Pulitzer (PTZ, news, msgs), New York Times, Tribune Co. (TRB, news, msgs) and Knight-Ridder (KRI, news, msgs) establishing new 52-week lows over the past few weeks, one might argue that much, if not all, the bad news is already priced into the industry. Doubtful. Though newspaper stocks have dropped an average 14% from their 52-week highs, valuations in the sector remain uncomfortably high, especially in light of the foggy advertising climate. The average price/sales multiple is 2.3, while the average forward price/earnings ratio is a still hefty 22.3. Among the more overvalued companies are Pulitzer, Hollinger International (HLR, news, msgs), New York Times and Dow Jones (DJ, news, msgs).
Meanwhile, earnings growth is seen slowing from an average of 17% in fiscal year 2004 to 12% in 2005. Worse, estimates for 2004 are coming down. As they do, future growth will likely be questioned. In a slumping earnings environment, paying a material premium to growth can be a very bad decision.
It's not all bad news
Is there some value in the group? Sure. At roughly 16 times current year estimates and 1.7 times trailing 12-month sales, Knight-Ridder is a relative bargain. Its operating margins and return on equity are also among the highest in the industry, as is its 1.97% dividend yield. However, with the shares down 19% off its high and 18% on the year, theres no rush to go out and load up on the stock. Youd do better to wait for the stock to build a base before hitting the buy side.
The same can be said for Gannett (GCI, news, msgs), Belo (BLC, news, msgs) and the Journal Register Co. Each of these stocks is trading at fair valuations with decent financials and modest dividend yields. Each is also displaying miserable price momentum. So, again, theres no reason to buy now as it would be akin to catching a failing knife.
Where investors might want to turn is to those stocks that have held up during the groups troubles on the assumption that once industry conditions improve these relative strength leaders will shine even brighter. A few stocks that match this description are:Unfortunately, Washington Post shares are selling at more than $866. As for the others, the two most interesting options are Lee and McClatchy.
Lee is a smallish regional player (mostly in the Midwest and West) that derives nearly 70% of revenues from advertising. However, earnings and sales growth has been relatively consistent, and the company is expected to post 10% bottom-line growth in both 2004 and 2005. Lee is also one of the few stocks in the industry holding on to a yearly gain. Its margins are high and defensible, and its dividend yield of 1.6% generous.
McClatchy is another regional player with solid growth, strong margins and impressive relative strength. (Its newspapers include the Sacramento Bee, Minneapolis Star-Tribune and the Raleigh News & Observer.) At two times its long-term growth rate, valuations arent cheap but, as long as the company can continue to deliver on its earnings targets, the stocks risk/reward ratio looks modestly bullish. While Scripps has held up relatively well, it recently fell short of earnings estimates and, as such, is too risky now.
Overall, the outlook for the newspaper publishing group is shaky right now given disappointing sales growth and a changing ad landscape. Consequently, investors considering this group will want to be very selective -- especially over the short-term.
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