QUALIPORT
Local Hero Johnston Press

By Maynard Paton (TMFMayn)
March 20, 2003

Local newspaper publisher Johnston Press (LSE: JPR) has turned into a bit of a Qualiport hero. Set against a falling market, the portfolio has seen a 30% gain on its Johnston shares over the past eighteen months. Yesterday's annual results explained why. The statement spotlighted the resilient nature of the company and the boardroom's sensible approach to acquisitions (quite a rarity in the media sector). A simple, visible business with a dominant competitive advantage, Johnston remains a great share for long-term investors. And at 347p, it's attractively priced, too.

Five-year review

The table below shows Johnston's five-year progress:

To 31st December           1998    1999    2000    2001    2002


Turnover (£m)             201.7   242.6   292.2   300.6   428.4
Operating Profit (£m)      51.0    65.9    85.0    90.7   131.2
Exceptional Items (£m)      0.7    (5.2)   (1.1)   (6.3)   (8.0)
Net Interest payable (£m)  (6.2)  (11.2)  (18.8)  (16.3)  (30.9)
Pre-tax profit (£m)        45.9    49.8    65.4     68.5   92.7

Earnings per share*(p)     14.2    17.3    21.0    23.7    26.8
Dividend per share (p)      3.5     4.0     4.5     4.9     5.4

(* before exceptional items)

The £573m purchase of Regional Independent Media (RIM) a year ago had a dramatic affect on Johnston's 2002 performance. In total, turnover increased 43% to £428m, underlying pre-tax profits jumped 35% to £101m, earnings per share improved 13% to 26.8p while the dividend was raised 10% to 5.4p per share.

In terms of Johnston's continuing businesses, minor improvements in advertising sales and circulation revenues helped sales creep 2% higher to £306m. Further cost reductions allowed operating profits to gain 6% to £96m. Operating margins thus carried on their longer-term trend, edging up from 30.2% to 31.5%.

As promised at the time of purchase, Johnston's management quickly made inroads into RIM's cost base. £4.8m of the forecast £9.0m of savings were found in 2002, with the balance to be generated this year. In 2002, RIM contributed revenues of £120m and provided a £33m operating profit. Under Johnston control, margins improved from 23% to 27%.

Cash flow

Last year witnessed Johnston continue its favourable cash flow characteristics:

To 31st December            1997    1998    1999    2000    2001

Operating Profit (£m)       51.0    65.9    85.0    90.7   131.2

Working capital change (£m)  0.0    (2.6)   (2.3)   (2.9)   10.4

Depreciation (£m)            6.8     9.2    11.5    11.6    16.7
Capital Expenditure (£m)    (7.9)   (9.0)  (19.9)  (24.3)  (13.5)

Johnston excels on the working capital front. But capital expenditure is a slightly different matter. There was a large jump in fixed asset expenditure during 2000 and 2001 following a major upgrade to the firm's printing presses. Looking back over the past five and ten years, net expenditure of tangible assets has been, on average, about 33% greater than the accounting depreciation charge.

At the end of December, Johnston's net debt stood at £503m. During the past year, interest payments were covered a net 4.2 times by operating profits. Given Johnston's operational stability, borrowings look comfortable, though hopefully the low-ish cover will rise in time.

Unfortunately, Johnston's generally low asset requirements and high level of borrowings don't filter through to the incremental return on equity figures. With pre-tax profits jumping from £26.2m in 1997 to £71.3m in 2002, and shareholders' funds (adjusted for goodwill and exceptional items) increasing from £221.6m to £636.2m over the same timescale, the incremental return on equity over that period comes to 10.9%. Not spectacular, and shows just how the sizeable RIM purchase has lowered recent returns. (As a benchmark, the five years ending December 2001 saw Johnston generate a 23% incremental return on equity.)

Still, Johnston has all the hallmarks of an above-average company, suggesting plenty of headroom for greater equity returns as and when RIM becomes bedded in fully.

Commendably, Johnston has already published its 2002 annual report, which among other things reveals the company's FRS17 pension deficit. At the end of December, the shortfall stood at £75m. With pre-tax profits of £111m possibly on the cards for the current year, the deficit doesn't appear overly worrying at the moment, but does need to be monitored.

Valuation and summary

Another year, another decent set of results from Johnston Press. At a time when many media firms are floundering, Johnston continues its steady progress to re-emphasise the robust qualities of the local newspaper industry.

For 2003, if it's assumed:

* Operating profits at Johnston's 'existing' businesses remain flat at £95.7m;
* RIM produces a £49.9m operating profit (based on its 2002 performance plus a further £4.2m of savings);
* Capital expenditure runs 33% ahead of depreciation;
* Interest payments of £36.3m are made on net debt of £503m;
* Profits are taxed at 30%, and;
* 283.4m shares remain in issue.

... next year could see earnings per share of 27.4p and free cash flow of 25.9p per share. At 347p, Johnston shares thus offers an attractive 7.5% free cash flow yield.

More: Why Buffett Buys Local Newspapers | Johnston Press: Interims 2002 | Full Year 2001

The author owns shares in Johnston Press.