QUALIPORT
Solid Growth In A Mature Market

By Maynard Paton (TMFMayn)
March 22, 2005

There can be few industries as mature as newspaper publishing. William Caxton set up the first English printing press way back in 1476, the first titled newspaper, Corante, was published in 1621, while the world's oldest paper still going today is the Worcester Journal, which started life in 1690.

According to the Newspaper Society, there are now around 1,300 newspaper titles in the UK. And despite the advent of radio, television and the Internet, about 85% of the adult population (40m people) still read a regional or local paper and 71% (33m) read a national. Indeed, as Warren Buffett knows, newspaper publishers remain genuine consumer franchises. Over time, individual towns, counties and countries have not been able to support a vast array of dedicated publications (and therefore competitors), while ongoing industry consolidation suggests newcomers can't readily expect to march into an established rival's patch. Read more.

Though the industry's underlying growth isn't spectacular, consistent cost-cutting and canny acquisitions can support solid earnings improvements. The best in the business is undoubtedly regional newspaper specialist Johnston Press (LSE: JPR). Even though the firm is one of the oldest players in the sector -- its history can be traced back to 1767! -- Johnston shows no sign of any profit maturity. In fact, earnings have almost doubled in the past five years. Currently the Qualiport's second largest share investment, Johnston's annual results last week emphasised why the company remains a portfolio favourite.

Five-year record

Johnston's five-year progress is summarised below:

Year to 31 December	1999	2000	2001	2002	2003	2004
Turnover (£m)	242.6	292.2	300.6	428.4	491.8	518.8
Operating profit (£m)	65.9	85.0	90.7	131.2	163.0	178.0
Exceptional items (£m)	(5.2)	(1.1)	(6.3)	(8.0)	(3.2)	(1.5)
Pre-tax profit (£m)	49.8	65.4	68.5	92.7	128.0	150.6
Earnings per share (p)	17.2	21.0	23.7	26.8	32.4	38.0
Dividend per share (p)	4.0	4.5	4.9	5.4	6.0	7.2

Progress since 2000 has been dominated by the £573m purchase of Regional Independent Media (RIM) in 2002. However, without the benefit of any subsequent acquisitions, Johnston still managed to report an encouraging performance in 2004. Aided by a 53rd week, total turnover increased 5% to £519m, underlying pre-tax profits improved 16% to £152m and headline earnings per share rose 17% to 38.0p.

Advertising sales (representing 76% of the group's top line) moved 5.5% ahead on a like-for-like basis in 2004, with employment and property adverts (both up 10%) being the star performers. The improvements partly stemmed from the launch of some specialised employment publications and a 'slowing' housing market causing 'vendors to work harder' to sell their homes. 'Display' and 'other classified' advertising registered modest growth, though income from motor advertising fell slightly.

What's really impressive about Johnston is its continual focus on cost control and how its high operating margin just keeps on improving. This time the margin edged from 33.1% to a very healthy 34.3%. (A presentation to City analysts revealed newspapers in Scotland generated margins of 41% in 2004. Meanwhile, the small print in the 2004 annual report indicated Internet revenues of £6.3m produced a profit of £3.6m -- a margin of 57%!).

For reference, the group operating margin was 'just' 28% in 2000. In 1994, it was 22%. The 2004 results also included the now usual (but relatively minor) exceptional item in the full-year results, which mostly concerned restructure costs (again).

Cash flow and balance sheet

Johnston remains a prodigious cash flow generator:

Year to 31 December	1999	2000	2001	2002	2003	2004
Operating profit (£m)	65.9	85.0	90.7	131.2	163.0	178.8
Change in working capital (£m)	(2.6)	(2.3)	(2.9)	10.4	(10.6)	(3.3)
Depreciation (£m)	9.2	11.5	11.6	16.7	18.0	19.5
Net capital expenditure (£m)	(9.0)	(19.9)	(24.3)	(13.5)	(18.1)	(22.5)

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%. However, capital expenditure can be lumpy and 2005 will witness a £60m investment in a new colour printing facility in Sheffield. Another £45m is earmarked for a similar operation in Portsmouth. Generally, annual net cash spent on tangible fixed assets exceeds the depreciation charge by 25%.

Johnston's strong cash flow helped net debt reduce from £423m to £328m during the year. Accordingly, gross interest cover improved from 4.9 to a reassuring 6.6 times -- the highest since 1998. The 2004 achievements also enabled the full-year dividend to be lifted 20% to 7.2p per share.

Progress, however, hasn't been so positive within the company pension scheme. At the end of 2003, Johnston reported a pre-tax FRS17 pension deficit of £65m. Twelve months on and despite the fund largely devoted to equities and a stock market rally, the pre-tax shortfall has expanded to £71m (equivalent to 25p per share). The deterioration was largely down to an increase in life expectancy assumptions and a reduction to the discount rate used to determine the present value of the scheme's liabilities. Still, with annual pre-tax profits running at £152m, Johnston's deficit doesn't appear overly worrying, but it does need to be monitored.

Valuation and summary

These were another good set of results from Johnston Press and nothing was revealed to worry its long-term 'franchise' investors.

Though overall revenue growth in the newspaper industry is never going to be a few percentage points above inflation, Johnston has demonstrated over the years that it is possible to churn out decent earnings growth in what is a very mature market. Consolidation and cost-cutting have been the major profit drivers, with Johnston developing a fine record for corporate activity. As well acquiring RIM in 2002, the last ten years has also seen Johnston buy Emap Newspapers for £211m in 1996 and Portsmouth & Sunderland for £266m in 1999 -- and no integration problems have ever emerged.

This track record also brings up another point -- with purchases seemingly made every three years, the next major acquisition looks to be due this year. Certainly Johnston continues to believe further consolidation is possible and interest cover at its highest level for six years indicates the company has the financial flexibility to make a sizeable move.

For the record, Johnston controls 13% of the regional and local newspaper market, with Trinity Mirror (LSE: TNI), Gannett (NYSE: GCI) and Daily Mail & General Trust (LSE: DMGT) dictating a further 58%. 'Trophy' purchases could include Archant (5% market share) and Midlands News Association (3%) -- competition rules permitting, of course. The 90-odd other, smaller, publishers (representing 17% of the market) may prove to be more realistic targets.

Finally, at today's 546p, Johnston shares stand on a price to earnings ratio of 14.4 and offer a 1.3% dividend yield. Accounting for the lower level of debt and assuming no profit growth, the current year could see free cash of around 36.9p per share being produced. The current free cash flow yield is therefore 6.8%. Demanding 7.5% requires a buy price of 492p.

Where next? Why Buffett Buys Newspapers | Newspaper Society

Maynard owns shares in Johnston Press.

Portfolio value

Holding	Number of shares	Closing price 14/03/05 (p)	Value (£)
Associated British Ports	681	482	3,282.42
Emap	372	851	3,165.72
Halma	1,920	163.5	3,139.20
Johnston Press	1,608	546	8,779.68
London Stock Exchange	2,018	469.25	9,469.47
Cash			207.07
Total			28,043.56