Qualiport

What has changed since we bought them?

Today we are interrupting the search for the next Qualiport share and looking in depth at the annual results for EMAP that were released on Monday. As we only get to officially hear from our Qualiport companies twice a year, I feel it is important that we see what we can glean from the announcement at the first available opportunity. We will be coming back to our search for a branded goods company on Friday. If you have a view about Unilever, Reckitt & Coleman and/or Cadbury Schweppes, feel free to share it on the message boards. We've already had a good thread going on the Web boards about Unilever.

EMAP was the second share added to our model Quality Portfolio. For those who would like a re-cap on the final buy report, and the other two shares we own too, check out the revamped Qualiport introduction section.

In the past few years, EMAP has been slowly but surely concentrating on building up branded publishing titles. They have big businesses in the UK and France and are looking to extend to the worldwide stage. The flagship UK title is men's monthly magazine FHM, which has the highest circulation out of the monthlies in the country. The French consumer magazines division, although the local economy has remained depressed for a considerable period of time, gives EMAP exposure to a region with potential recovery prospects. Having said that, even now France is providing profit growth for the group through significantly increased margins, but sales when converted to sterling aren't growing. The forthcoming World Cup may help kick-start the French economy.

The Numbers

All numbers quoted here are as published, and as translated into sterling at the effective exchange rate used by EMAP. The so-called "underlying" numbers, as quoted by EMAP and other companies, refer to the change in numbers from one year to the next on continuing businesses and at constant exchange rates. These figures can sometimes give you a feel for the real performance of the business, as you are comparing like with like. Personally, I like always to look at the actual numbers as reported at the prevailing exchange rate. In the long-term, the currency movements will ultimately work themselves out, and it is just part of running a multinational business. You didn't hear many companies saying "the weakness of sterling masked our underlying constant currency growth of only 2%, despite our published figures intimating that we grew by 10%" back post White Wednesday. Anyway, enough of all this, here's the numbers in £m:

Sales 772.6 (+1%)
Operating profit 142.5 (+13%)
EPS 45.7p (+18%)

The first thing that stands out is the anaemic sales growth of just 1%. As a shareholder, I find this a little disappointing. Great companies must increase their sales in order to constantly increase their profits. Margin improvement is great, and is normally the sign of a well managed company, but ultimately long-term sustainable growth must start at the top line. The French Consumer Magazines division was the main culprit, where total sales fell by 11% to £225m. This highlights what I was saying earlier about the still depressed French economy. Looking on the bright side, there is possibly considerable room for improvement in what may be a recovery type situation. EMAP are continuing to invest in economy via new launches, and this plan of action has served the company well in the UK.

Of the other divisions, Business Communications sales only grew by 4%, but has been through a year of rationalisation. The acquisition of the Healthcare titles from Macmillan for £103m included Nursing Times, one of the top three paid-for professional titles in the UK. EMAP are confident about the future prospects and growth of this division.

UK Consumer Magazines sales grew by almost 16%, and this division has been the real winner for EMAP. In this year, they launched the women's glossy Red, which has been well received. EMAP prudently used the continued weakness in paper prices to invest in the quality and promotion of titles, positioning them for future growth.

Radio has had a solid year, and sales grew by 10% to £70m. In 1997, EMAP were confirmed as the market leader for the 15-44 audience with a 17.7% share of listeners. They continue to invest in the Magic brand name, and recently bought London's Melody Radio. As part of that acquisition, out went Cardiff's Red Dragon Radio, sold to Qualiport media company runner up Capital Radio.

The International/New Media division is the interesting one, and is an area that could provide the company with significant growth prospects in the years to come. Ongoing projects include forays into the magazine markets of Australia and Singapore, the Internet, and television via masthead programming. The latter means that soon we will be able to see commercial television programmes which are based on successful magazines -- the obvious choice for EMAP would be FHM, although it is doubtful that BBC1 would be game enough to carry it!

Margins

My favourite. The 1% turnover growth was translated into earnings per share (EPS) growth of 18% simply by EMAP tweaking its operating margins upwards. You may remember that EMAP's stated aim is to increase them to 20% by the year 2000, earlier if possible. From continuing businesses, they were 16.4% for fiscal 1997. They are now 18.4%, and well on target for 20% in two years' time. Margins increased in all divisions except radio, where the launch of EMAP On Air, their new national sales company, depressed profits.

Cash

At the year end, EMAP's net debt was £149m, up from £89m a year ago. This was mainly due to the company's ongoing acquisition programme, with the Macmillan purchase being the big one of the year. Gearing, taken as a percentage of goodwill adjusted shareholder's equity (£617.5m), is a very manageable 24%. Barring any major disposals, EMAP probably have the ability to borrow up to a total of £400m and more if the right opportunity came along. In fiscal 1999, they should again produce free cash flow before acquisitions and dividends of about £90m.

EMAP uses operating cashflow after expenditure on tangible fixed assets, expressed as a percentage of operating profits as its key cash management measure. Their long term aim is to achieve a conversion ratio of at least 95%. This is quite a demanding target and highlights the importance the company places on cash generation. Over the last 5 years the ratio achieved has been 98%, and in 1997 it was 100%. A net cash generator usually has more money to spend on enhancing shareholder value, either through increased dividends, share buy backs, or acquisitions. In 1998, EMAP fell slightly short of their target, achieving a 94% conversion ratio. This is nothing to get too worried about, as it is a demanding target. Again in this year's report, EMAP emphasise that this a key management tool.

Current Valuation & Prospects

When the EMAP buy report was written in early April, consensus earnings estimates for fiscal 1998 were 45.1p per share. At the time, I said "I'd obviously like to see (that) beaten." Well, they did it (45.6p), but only just. In years past, EMAP has quite often beaten earnings estimates by a bigger margin than this. When companies who have this happy habit meet or only just beat expectations, the market can often react negatively. In fact, EMAP's share price went down on the day of the announcement, and down further the next day, before bouncing a bit today. Don't forget to check the latest Qualiport numbers.

The upshot of the earnings announcement is that virtually all the valuation models and assumptions we made at the time of the buy report still stand. That's disappointing in one respect, because we would have liked to see EMAP produce something extra special. On the other hand, you could look at this positively insofar as predictability of earnings.

The share price has risen by over 5% since our purchase less than 2 months ago. This has removed some of the margin of error that we like to see. Using the compounding retained earnings model, over the next 5 years you could expect a compounded annual growth rate (CAGR) per annum of just under 6%, and just under 10% over a 10 year timeframe. Using the Warren Buffett Way, discounting cash flow method of valuation, the current market capitalisation could be at a 23% discount to the implied intrinsic value. And using the compounding EPS growth model, the 5 year CAGR could be 6.7% and the 10 year CAGR 11.2%, before dividends.

At about 1250p, EMAP trade on a trailing price to earnings ratio (P/E) of 27. This is quite high, given that their growth rate is slowing, especially sales. The company remains very confident and says "EMAP has demonstrated exceptional growth in recent years, and has the depth of management and the vision to continue that growth. The company can look forward to the future with great confidence," and "The coming years will provide opportunity for companies with strong cash flows and financial capacity. EMAP is such a company and it looks to the future with confidence."

Blindly accepting confident outlook statements is an occupational hazard for the unwary. In the past, and in this report, EMAP has always been realistic about its prospects, both good and bad. They recognise that double figure like-for-like advertising growth in the UK is not sustainable, and that pulp paper prices will not stay this depressed forever.

EPS estimates for fiscal 1999 are expected to remain largely unchanged at 51p, which is growth of almost 12% from 1998. EMAP therefore trade on a forward P/E of 24.5. They are certainly no screaming bargain, which is what we said back at the time of the buy report. However, there was nothing in these numbers to suggest that they aren't a well-managed company with good long-term prospects. That is what we are after in our Qualiport companies. We're happy to hang on to EMAP.

Any and all comments encouraged to the message boards.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers            Date    03/06/98


          Change     Bid
          pence       £

RTO        0.03      4.15
EMAP       0.05     12.47
MKS       -0.04      5.48         


Rec'd        #     Stock      Buy      Now    % Change   £ Change

19/12/97   1565 Rentokil      2.55     4.15     62.7%       1.60 
17/04/98   337  EMAP         11.85    12.47      5.2%       0.62 
11/05/98   722  M & S         5.535    5.48     -1.0%      -0.055


19/12/97   1565  Rentokil  4,040.63  6,494.75   60.7%   2,454.12 
17/04/98    337  EMAP      4,043.37  4,202.39   3.9%      159.02
11/05/98    722  M & S     4,052.24  3,956.56  -2.4%      -95.68

Cash                                    33.96

Total                               14,687.66 


                Day    Month    Year    History

Qualiport       0.2%   -1.6%    51.0%    54.4%
FTSE 100        1.0%    0.5%    14.9%    17.5%
FTSE All Share  0.8%    0.4%    16.7%    19.2%