QUALIPORT
Qualiport Favourite Johnston Press

By Maynard Paton (TMFMayn)
March 18, 2004

Representing a third of the portfolio, Johnston Press (LSE: JPR) is currently the Qualiport's largest share investment. Yesterday's annual results emphasised why the company remains a favourite.

As Warren Buffett knows, newspaper publishers such as Johnston are genuine consumer franchises. The sector does not support a vast array of titles (and therefore competitors), while ongoing industry consolidation suggests newcomers can't readily expect to march into an established rival's patch. It all means shareholders of Johnston can expect strong, reliable cash flows for many years to come. Read more.

(And another sign of class: Johnston has already managed to publish its full 2003 annual report on its website.)

Five-year record

Johnston's five-year progress is summarised below:

Year to 31 December	1999	2000	2001	2002	2003
Turnover (£m)	242.6	292.2	300.6	428.4	491.8
Operating profit (£m)	65.9	85.0	90.7	131.2	163.0
Exceptional items (£m)	(5.2)	(1.1)	(6.3)	(8.0)	(3.2)
Pre-tax profit (£m)	49.8	65.4	68.5	92.7	128.0
Earnings per share (p)	17.2	21.0	23.7	26.8	32.4
Dividend per share (p)	4.0	4.5	4.9	5.4	6.0

The growth rates seen in 2003 were flattered by the £573m purchase of Regional Independent Media (RIM) in 2002. In total, turnover increased 15% to £492m, pre-tax profits improved 38% to £128m and underlying earnings per share rose 21% to 32.4p.

Advertising sales (representing 75% of the group's top line) edged 4% higher on a like-for-like basis, with property adverts -- up an underlying 15% -- the star performer. Interestingly, a 'cooling' in the housing market had caused 'vendors to work harder' to sell their homes. Employment, motor and other classified advertising registered modest growth, though income from 'display' advertising fell slightly.

Johnston continues to make further margin improvements. The operating margin edged from 30.6% to a healthy 33.1% during 2003, with the performance of RIM attracting particular interest. Operating profits at RIM during 2001 -- the year prior to Johnston's takeover -- were £40m. Two years on, £57m has now been achieved, which suggests the management has exceeded the original £9m of anticipated synergies by a wide margin (RIM's 2003 operating margin was 32.9%). There was, however, the now usual (but relatively minor) exceptional item in the full-year results, which mostly concerned restructure costs (again).

Cash flow

Johnston remains a prodigious cash flow generator:

Year to 31 December	1999	2000	2001	2002	2003
Operating profit (£m)	65.9	85.0	90.7	131.2	163.0
Change in working capital (£m)	(2.6)	(2.3)	(2.9)	10.4	(10.6)
Depreciation (£m)	9.2	11.5	11.6	16.7	18.0
Net capital expenditure (£m)	(9.0)	(19.9)	(24.3)	(13.5)	(18.1)

Over the past five- and ten-year periods, cash diverted into working capital has on aggregate been below 2% of annual operating profits while net payments on tangible fixed assets have on average absorbed just 15%. Johnston's strong cash flow helped net debt reduce from £503m to £423m during the year, leaving gross interest cover at a manageable 4.9 times. The performance also enabled the full-year dividend to be lifted 11% to 6p per share.

Although the company enjoys a generally low requirement for assets and can safely maintain a relatively high level of borrowing, Johnston's incremental returns on equity have not been that spectacular. With post-tax profits jumping from £32m in 1998 to £92m in 2003, and shareholders' funds (adjusted for goodwill and exceptional items) increasing from £246m to £713m over the same timescale, the five-year incremental return on equity comes to 12.9%. Not bad, but shows how the £710m(!) of goodwill acquired in the last five years has dampened returns.

At the end of 2002, Johnston reported a pre-tax FRS17 pension deficit of £75m. Though one-off contributions amounting to £13m were made during the past year, the shortfall at the end of 2003 still came to £65m. Indeed, Johnston's lack of pension progress contradicts the belief that the stock market rebound has reduced pension deficits significantly. In Johnston's case, though the fund's assets increased by £40m, the projected liabilities in turn increased by £30m (due in part to greater inflation, salary and pension payment assumptions). (Consultancy Watson Wyatt has more on this issue.)

Still, with annual post-tax profits of £92m, Johnston's deficit doesn't appear overly worrying at the moment, but it does need to be monitored.

Valuation and summary

These were good results from Johnston Press and revealed nothing to concern its long-term 'franchise' investors. Particularly pleasing has been the integration of RIM, which the boardroom described as exceeding expectations in terms of 'progress, performance and payback'. It's generally quite rare for investors to witness a sizeable acquisition go so smoothly, and rarer still to find a company such as Johnston that has developed a fine record for corporate activity over the years (prior to RIM, Johnston bought Emap Newspapers for £211m in 1996 and Portsmouth & Sunderland for £266m in 1999).

More acquisitions would seem to be on the horizon. Johnston remarked on industry market shares (it controls 14%, with Trinity Mirror (LSE: TNI), Gannett (NYSE: GCI) and Daily Mail & General Trust (LSE: DMGT) dictating a further 55%) and has hinted on making further gains. Though buying handfuls of titles is more likely than acquiring whole companies, potential 'trophy' purchases could include Archant, Midlands News Association and DC Thomson (competition rules permitting).

At 514p, Johnston shares stand on a price to earnings ratio of 15.9 and offer a 1.1% dividend yield. Accounting for the lower levels of debt and assuming no profit growth, the current year could see free cash of around 31.6p per share being produced. The current free cash flow yield is therefore 6.1%. Demanding 7.5% requires a buy price of 421p. Not cheap enough to top up then, but not so expensive to trim the Qualiport's largest holding either.

Where next? The Share Making All The Headlines | Local Hero Johnston Press | Why Buffett Buys Newspapers

The author owns shares in Johnston Press.