These are the Good Old Days
by Kevin Gruneich, CFA
"We can never know about the days to come, but we think of them anyway.
And I wonder if I'm really with you now, or just chasing after some finer day.
Anticipation. Anticipation is making me late, is keeping me waiting. I’m no prophet; I don’t know nature's ways. So I’ll try and see into your eyes right now. And stay right here, ’cause these are the good old days." -- Carly Simon (Electra - 1971)
It may seem odd for somebody in the financial services industry to quote Carly Simon’s 1971 hit, “Anticipation” -- even more so than newspaper publishers that have just suffered through the worst ad recession in decades. But as in 2000 and 2001, the past year actually encompassed the good old days for newspaper stock performance. The Bear Stearns Diversified Newspaper Index, a composite of stocks we cover in the industry, easily outpaced the S&P 500, +4.1% to -23.4%. Among stocks we cover, Tribune Company and The EW Scripps Company were the premier performers, up 21.5% and 16.6%, respectively.
Investors were drawn to the diversified newspaper stocks given their excellent free cash flow, and moderate leverage on balance sheets that lack the complexity that got other companies into trouble in 2002. We also think the stocks were helped by lack of “mogul-ism” that proved to be a problem elsewhere in the broader media industry. After all, the past year saw the fall of some high-profile media moguls who exhibited large doses of hubris -- not associated with the newspaper biz. Multiples (earnings, cash flow, and/or free cash flow) are also among the lowest in the broad media universe. Thus, pricier broadcasting and entertainment stocks provide somewhat of a valuation umbrella or downside protection.
Beyond that, newspapers enjoy superior pricing power, at least on the advertising side, relative to Corporate America. Fear of Internet competition, rampant as recently as 1999, was further flushed out of the stocks -- yet another positive development. Pure Internet competitors in the recruitment sector continued to be worrisome and certainly have had a negative impact on publishers’ pricing flexibility, while raising selling costs. But such interlopers -- while potent on the national scene have struggled to make inroads locally, the geographic source of most recruitment advertising. The potential approach of media deregulation, hoped for in 2003, most notably the loosening or elimination of the newspaper/broadcast cross-ownership restriction, also could have helped out. Private market values are higher than public market values, making an acceleration of M&A in the year ahead a positive development for the stocks.
Having said that, the past year presented a difficult operating environment for newspaper publishers. Late in 2001, we projected that industry ad revenues would decline 0.5% after falling 8.9% in 2001. Unfortunately, that estimate will be very close to correct. Through three quarters, the Newspaper Association of America reported that industry ad revenues declined 2.3% year-over-year, dragged down primarily by a still-depressed recruitment sector. The silver lining is the consistent progress -- -improving advertising comparisons throughout the year, finally moving into positive territory this past summer. Retail advertising has been surprisingly strong as consumer spending remained surprisingly healthy throughout the year. Preprint advertising was a key driver as retailers became more promotional. Also, consumer electronics and home improvement chains have meaningfully broadened product offerings in recent years, translating into more insert pages.
In the back half of the year, national advertising in newspapers accelerated into positive comparison territory with the strength being broad-based, as most publishers could mention multiple sources of strength -- most notably entertainment, travel/resorts, financial services, telecommunications, and packaged goods. Within classified, only recruitment was a drag with the other two sectors -- automotive and real estate -- experiencing positive comparisons throughout the year, especially impressive in the latter category given real estate ad revenues climbed 10.9% in an otherwise dreary 2001. Thus comparisons were difficult.
Good cost control and lower newsprint pricing -- down an estimated 21% for full-year 2002 -- were key to sharp earnings growth for the year. The aforementioned free cash flow and much lower interest rates were also key positives, driving 2002 earnings per share up an average of 14% at diversified newspaper companies we cover. That’s against an average 20% decline in 2001.
So the past year represented a “baby step” out of the ad recession but a “giant step” out of the earnings basement. Thus, we think the year ahead will be one of even better ad revenue growth but less dramatic earnings growth than 2002. We are expecting newspaper ad revenue growth of 5-6% -- that’s ahead of consensus. Recent momentum should build, especially in national advertising. And help wanted comparisons should turn the corner into positive territory early in the year. Given these categories are higher-rate, ad yields -- or revenue per inch -- should be relatively healthy with a richer mix.
We believe earnings growth could average about 12%, still better than the market, but not dramatically better, as exhibited in 2002. One of the problems is expense control. Several newspaper companies met the challenges of 2001 with meaningful cost cutting, much of it relating to staffing. But much of that seems to be behind us. Rising pension and healthcare expenses are boosting labor costs at a mid-single-digit rate in 2003 at the same time newsprint pricing is beginning to move up. We currently believe that newsprint pricing could be up 9% in 2003.
Newspaper publishers may wish for better days but they should not wish too hard -- at least publishers of public companies. They generally have performed admirably during the three years of market downdraft as the stocks have acted quite defensively. In fact, we regularly track the “defense ratio” regarding the stocks; that is, weeks in which the market (as measured by the S&P 500) is down, the Bear Stearns Diversified Newspaper Index outperforms, and vice versa. Thus, the strong market may not be the best thing for relative newspaper group performance. Ditto for a robust economy that may (on a relative basis) leave newspapers behind. After all, the industry has not had a double-digit ad revenue growth quarter since 1987.
Thus, the “Goldilocks” economy of the recent past -- not too hot, not too cold -- would be most beneficial to newspaper stocks. The good old days for this group are not filled with sunshine -- just partly sunny.
Kevin Gruneich, C.F.A., is a Senior Managing Director of Bear, Stearns & Co., Inc., a leading global investment banking, securities trading and brokerage firm. Gruneich covers the publishing and information services industry. He has been named to Institutional Investor’s All-America Research Team for the past 19 years, and has been named top analyst in his field eight of those years. Euromoney magazine has listed him among the top publishing analysts in the world. In this piece written for Newspaper Acquisitions, Gruneich offers his outlook for the newspaper industry in 2003.