Stockwatch: What's next after this share doubled in three months?

This is a hugely successful tip for our companies analyst as last year’s rally spills over into 2020.

Is it time to sell this mid-cap media/publishing stock which has nearly doubled from pre-election levels?

Reach (LSE:RCH) is re-incarnating from its black-sheep days as small cap Trinity Mirror – weighed down by liabilities of debt, the phone hacking scandal, declining circulation for The Mirror newspaper – and being a smaller version of BT by way of “pension fund with a company as ancillary”.

Chart and fundamentals’ context remains "recovery"

Even on a five-year view, the stock looks over-bought in the short term, having formed quite a “saucer” (potential for advance) from March 2018 to November 2019, then a parabolic rise.

Yet, on a 20-plus year view it is only near the top of a sideways’ consolidation range since 2009, down from peaks at around 700p in the early noughties and having breached 200p in 2014.

On such a technical view the current rise is significant, suggesting that if it holds around this level then more definitive advances are possible in the medium-term – perhaps the next two years. 

Source: TradingView Past performance is not a guide to future performance

As a chiefly fundamentals-oriented analyst you’d expect me to be sceptical of such a backwards-looking mirror. Didn’t historically higher share prices grossly underestimate the realities of trouble brewing – in terms of liabilities and the business model requiring a fundamental overhaul?

Yes, but I think the chart still justifiably shows some longer-term scope for mean reversion considering the 2019 results price/earnings (PE) ration is only just over 4x and as liabilities get whittled down then phenomenal cash generation - £147 million from operations - should be able to build the payout from a yield that’s currently sub 4%.

From media scavenger to cutting-edge digital growth

I’ve previously drawn attention to Reach as a “buy”, from 66p in early 2018, on the basis that the CEO (appointed 2012) seemed finally to be defining a turnaround – by way of exacting synergies, cutting debt and buying the Express and Star newspapers, towards economies of scale as a “red-top” publisher.

In May 2019, on a 9%-plus dividend yield, I considered it still a “buy” at 83.5p, and “hold” last December at 93p on the basis of a 7%-plus yield according to forecasts. While I thought the risk/reward profile tipped positively after a “steady Eddie” trading update, I was a tad cautious as to how successful the Mirror, Express and Star titles could prove, bolstered by digital revamp.  I was encouraged by a new CEO and CFO joining, towards fresh initiatives, and concluded: “Ultimately it’s a question whether digital can prevail.”

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Coincidentally, in recent weeks I’ve replaced my desktop PC and phone, being impressed how their browsers have picked up on Mirror and Express stories to highlight in news feeds.

I sense Microsoft Edge is liberal-left given articles also by the Guardian, Independent, CNN and Washington Post – but I’ve also noticed Google picking up on Mirror articles when I’ve searched topics. Google News even seized on an Express piece to flag latest Meghan of Sussex news as the summary article, on my phone. It says, editorially and in terms of distribution, the Mirror and Express now command attention digitally.

Slipping revenue but humungous cash generation

Yesterday’s full-year results show revenue easing 3% overall to £702.5 million, despite a full year’s contribution from the Express & Star acquisition, with like-for-like revenues down 5.3%, although that is better than a 6.6% fall in 2018.

Circulation has appeared resilient enough to absorb cover price increases, while advertising revenue fell by 19.4% after 16.2% in 2018, although a shift to digital is underway everywhere. Digital revenues rose 13.2% compared with 9.6% in 2018, with average monthly page views up 25% to 1.3 billion.

As ever, it’s a tale of two parts, with cash generation the redeeming feature. Previously its strength convinced me the group could manage through its liabilities, now it looks able to define a “recovery to growth” status change in years ahead by way of further enhancing digital content, and also (in due course) meaningful dividend growth.

This is helped also by a circa 19% operating margin – near 22% based on normalised profit, and £147.4 million cash generated from operations last year has enabled a £60 million loan to be retired, eliminating debt - £48.9 million applied to the pension deficit (down from £90.1 million) and £18.6 million paid out as dividends. This keeps year-end cash pretty similar at around £20 million.

Don’t be deterred by negative net tangible assets

The pension fund deficit is down 9% to £327.1 million in context of £635.2 million net assets, although they are swollen by £852 million intangibles. But you are going to see hefty intangibles where media assets are involved, and the goodwill element (i.e. premium to tangibles paid during the Express/Star acquisition) is a relatively modest £42 million.

Warren Buffett has argued in Berkshire Hathaway’s annual reports, that newspapers’ durable franchise is a prime example of why you should respect intrinsic value on the balance sheet. I think that’s a dated view given new challenges presented by digital, and the risk that any media title can lose its way.

But, if the underlying trend as represented by circulation/viewers and advertising is robust, then so should be intangible value. Admittedly, if Reach hits a ceiling where digital doesn’t compensate for declining print, and can’t in the fullness of time define growth, then “asset impairment” comes into question.

For now, however, it seems worth giving management further credit to evolve a new aspect of strategy, like an ambitious target for Reach’s sub-1 million digital-registered customers at end-2019 to soar to 7 million by end-2022. It’s already the fifth-biggest digital asset in the UK after Alphabet (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT), and its total digital and print “reach” is 47 million people. 

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The current CEO (since last August) cites “strong foundations on which to invest and innovate to ensure a sustainable future for our trusted brands….content is at the heart of the new customer value strategy…we have an unmatched reach in UK media and will deepen our relationships via increased customer engagement…we see significant potential to accelerate the diversification of our digital revenue and capture more value…”

At the end-July interims, an update will be given on key monetisation themes, then an overall digital revenue target and timeline with the 2020 year-end financial results.

All that offers fair reasons not to take a conservative bean counter view of £852 million intangibles being dubious.

While the pension deficit has been seen as a ball and chain, the extent of cashflow makes it an issue (like debt before) that can be managed down. It’s a current constraint on dividend expansion but not a distress factor. Reach’s weak Altman Z credit score of 1.0, implying a serious risk of financial distress within the next two years, I believe says more about the historic basis to credit scores.

Forecasts need upgrading

2019 net profit has turned out at £121.7 million versus the £116.8 million predicted (by way of past published consensus), hence upgrades are likely for the £110.6 million pencilled in for 2020.

Normalised earnings per share (EPS) has turned out at 41.1p versus 39.2p expected. The outlook statement cites “confidence in further good progress through the rest of the year, delivering customer-focused objectives and digital growth ambitions” – so, it’s hard to assume a dip in the financial trend as analysts have assumed.

One would need to assume a doomsday scenario of older folk terrified enough by a UK coronavirus epidemic to stop venturing out to buy a paper, which is way off.

Although the phone hacking scandal rumbles on, with an £11 million rise in provision in the latest accounts, it is no company breaker and is well in the past.

I think the stock continuing to edge up, currently at 181p despite the coronavirus hit to markets, reflects a sense that “recovery to growth” stands a fair chance here, hence a continued re-rating of the PE and, as the pension deficit comes down further, dividend expansion. With fresh money, the stock is a candidate to buy, hopefully on any dips.  Broadly, though, it still rates a Hold.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.