QUALIPORT
Qualiport On Heat

By Maynard Paton (TMFMayn)
May 30, 2002

Qualiport company Emap (LSE: EMA) published its annual results on Tuesday. As has been the case for some time, the numbers were a somewhat complex affair. Even so, the company's market-leading media assets and cash flow characteristics remain attractive as ever.

(To provide some background to Emap, you may wish to read this review of the business and this assessment of the group's previous interim results).

Emap's five-year financial record is shown in the table below:

(to 31st March)             1998     1999     2000     2001      2002

Turnover (£m)              772.6    880.1  1,102.8  1,153.0   1,029.0
Operating Profit* (£m)     142.5    171.3    223.1    234.0     198.0 
Exceptional Items (£m)       0.5     12.5     67.5   (626.0)    (16.0) 
Pre-tax Profit (£m)        142.0    174.4    252.0   (429.0)    115.7 

Earnings per share* (p)     44.0     48.7     53.7     56.8      45.6 
Dividend per share (p)      14.4     16.6     18.3     19.5      19.5 

(*adjusted for goodwill, exceptional items, write downs and digital expense) 

Emap's headline profit performance over the past few years is largely academic. To recap, the company bought US publishing group Petersen in 1999 for around £900m. But various problems ultimately caused Emap to sell the business for £366m last August. Large write-offs relating to the disposal were charged to the accounts during fiscal 2001. Combined with costly-but-now-curtailed expenditure on Internet activities too, the performance at Emap's core businesses (UK and French consumer magazines and UK radio) has been rather clouded.

On an underlying basis (i.e. excluding US and digital businesses), the table below highlights Emap's latest annual performance at its 'continuing' divisions:

Division             Sales       Operating Profit      Margin
                    2002  2001      2002    2001     2002   2001
                      (£m)             (£m)             (%)

Consumer Media      324   299        45     50       14     17
Communications      194   210        54     61       28     29
Performance         139   141        41     46       29     33
France              262   239        43     40       16     17

Total               919   889       183    197       20     22

On an ongoing basis, sales rose 3% to £919m and operating profits fell 7% to £183m.

On the Consumer Media side, costs associated with establishing FHM in the States (Emap's only US magazine) caused the profit shortfall. Following strong circulation performances from Heat, New Woman and Motor Cycle News, Emap's share of the UK consumer magazine market edged up from 17% to 18%.

The disposal of Emap's German B2B operation caused the decline within the Communications division. On an underlying basis, sales and profits slipped just 1-2%, as titles such as Local Government Chronicle, Nursing Times and Construction News continued to serve resilient or relatively buoyant sectors.

An 8% slump in the radio advertising market hampered progress at Emap's Performance division. The company's radio stations, which include Kiss, Magic and Big City, saw their revenues decline 10%. Divisional profits fell 11%.

Only Emap's French consumer magazines reported improved sales and profits. Excluding the affect of an acquisition, both sales and profits grew by 5%. Unlike its UK equivalent, the French advertising market currently underpins a strong divisional performance.

Cash flow and ROE

Even with areas of Emap's business experiencing tough trading conditions, group operating margins of 20% still show the inherent strengths of the company. Furthermore, the latest figures reaffirmed Emap's very low appetite for working capital and fixed assets:

(to 31st March)              1998     1999     2000     2001    2002

Operating Profit (£m)       142.5    171.3    223.1    234.0   198.0

Working capital change (£m)  (3.5)   (13.3)    (8.8)     1.0    (8.0)

Depreciation (£m)            10.4     12.7     14.3     15.0    14.0
Capital Expenditure (£m)    (16.5)   (12.1)   (12.0)   (19.0)  (10.0) 

Encouragingly, the results showed that the large working capital outflow seen at the interim stage had been reversed. It's also worth noting from the latest figures that Emap is capable of generating operating profits of around £180m from just £30m of tangible fixed assets. As such, the company obviously relies on attractive, difficult-to-replicate intangible qualities. The annual numbers also showed net debt had declined from £677m to a relatively comfortable £277m.

Unfortunately, the asset-light nature of Emap's business isn't obvious when reviewing the company's incremental return on equity. Depending on how you account for the large write-offs (over £500m for Petersen alone) and the Internet expenditure, the incremental return on equity over the five years ending March 2002 is anywhere between 6-10%.

But with Petersen gone and digital operations set to breakeven in the current year, Emap's past profitability can be used as a rough guide to the company's forward potential. Although recorded during a relatively buoyant period for media firms, Emap's incremental return on equity over the five years to March 1998 was a robust 22%.

Valuation and summary

While Emap remains a fundamentally attractive business, the company is not without its risks:

For starters, boardroom changes are on the cards. Chief Executive Robin Miller confirmed that he is to retire from executive duties in July 2003. Miller led Emap to great success between 1985 and 1998 and has helped stabilise the company following his return last year. The hunt for Miller's replacement is now underway.

In addition, the forthcoming relaxation of media ownership rules could inspire another acquisition disaster. Reassuringly, Finance Director Gary Hughes was keen to emphasise during a teleconference that any purchase would be made "at the right price". Hughes believed that a "broad based consolidation premium" was presently priced into radio shares at the moment. Hughes also confirmed Emap was not involved in any corporate discussions at the moment.

In terms of valuation, if we assume...

* 'Continuing' operating profits are maintained at £183m;
* Depreciation reflects ongoing capital expenditure;
* Net interest of £15m is payable on net debt of £277m;
* Profits are taxed at 28%;
* Minority interests claim £6m (in line with fiscal 2002), and;
* Digital expenditure is ignored

... then Emap should be able to generate 50.0p of free cash in its current financial year. At the present 878p share price, the shares offer a prospective free cash flow yield of 5.7%. Demanding a free cash flow yield of 7.5% would require a share price of 667p.