Web Extra: In “Go Off The Rails” the Fast Money traders take on a newspaper’s analysis of rail stocks. Which newspaper?

The New York Times questioned whether rail shares are now overloaded in Sunday’s paper. Find out how the traders respond in Monday’s Web Extra.

The New York Times (NYT) scores horribly in the models I use. Its earnings quality is average, but it ranks among the worst for earnings momentum, price momentum, free cash flow and return potential. Meanwhile, pricing power indicates that the railroad stocks may have further to go.

photo credit: qnr

This article is a reprint of my February 21, 2008 RealMoney column

The last year hasn’t been a good time to own a newspaper. The best performing stock was Washington Post (WPO), which managed not to decline significantly. New York Times (NYT) and Gannett (GCI - Annual Report) are down as much as half, while smaller firms like Lee Enterprises (LEE), Belo Corp. (BLC - Annual Report), McClatchy (MNI) and Journal Register (JRC) have registered declines ranging from 60-80%.

Always on the eye for a contrarian opportunity, I wondered if the time might be right to take a stake in one of the papers. The one that most attracts my eye is Lee. Lee provides of local news, information and advertising in primarily midsize markets, with 50 daily newspapers and a joint interest in five others, rapidly growing online sites and more than 300 weekly newspapers and specialty publications in 23 states. In 2005, the Company acquired Pulitzer and has since trimmed the combined operations by selling certain local papers and printing operations.

Although its valuation multiples and price performance resemble those of the other small firms, Lee is less heavily leveraged (a mere 3:1 debt/market cap ratio compared to 4:1 at McClatchy and 12:1 at Journal Register) and generates a significantly higher free cash flow yield than those firms. Compared to Belo, its Zacks rank of 2 indicates favorable earnings revisions, while Belo is in the worst category.

However, it will take more than being the best in a rotten bunch to make me take the plunge. Lee has to offer some real value, and pay me for the risk I would be taking by owning the name. At first glance, the 10% free cash flow yield (operating cash flow plus after-tax interest expense minus capital expenditures, divided by enterprise value) and 6.4% dividend yield would appear to do the trick. But are they sustainable?

There doesn’t appear to be much near-term risk to the dividend due to its relatively small share of annual cash flows. Pension plan is under-funded by $75 million, but the annual required contributions are just a few million.

The biggest concern relates to $306 million in notes issued in conjunction with the Pulitzer acquisition, which are due in April 2009. It would be tough to come up with that money in the current credit environment, but at some point over the next year I expect the credit markets to return to normal. Under its credit agreements, Lee can also increase its line of credit by up to $500 million as long as it meets certain financial criteria.

The Best Laid Plans

Over the longer term, Lee will have to generate at least modest revenue growth (the consensus five-year estimate is 5%) and execute according to its plan. Unfortunately, the plan is running into some road blocks.

Lee Enterprises’ Stated Corporate Plan

Source: Company filings

Earnings Quality

Until the management can effectively put their plan into action, revenues and earnings look set for continued declines. In 2007 operating income decreased $5,157,000, or 2.5%.

Tax settlements reduced income tax expense by $6,880,000 in 2007. On an apples to apples basis, earnings per share declined from $1.82 to $1.66.

While the earnings are declining, they do appear trustworthy. The accrual ratio measures the difference between cash-based earnings and accounting (accrual) based earnings. The closer to zero, the better. With the exception of a spike in 2005 related to the Pulitzer acquisition, Lee’s earnings quality has been high.

Source: Zacks Research Wizard, compiled by William A. Trent

I Would Look to Enhance Yield With Options

Although a put-write may offer another alternative play on the name, the options are thinly traded. The March 12.50 puts are available for approximately $1.45 at the time of writing, while the March 10’s are trading at about $0.30. The choice would depend upon the investor’s objective: someone wanting to own the shares at a lower price could use the $12.50’s to get an effective purchase price of just over $11.00, while an investor who doesn’t really want the shares could get a 3% one-month yield on money at risk using the 10’s.

I also think if I wrote put options and ended up with the shares, I would turn around and write covered calls to continue enhancing the yield and offsetting some of the risk.

Disclosures: None

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

The topic of a la carte cable service (consumers being able to choose and pay for specific channels they want, and no “basic” tier) has been a big topic of discussion from time to time. Today it gained new attention due to comments by FCC Chairman Kevin Martin (via Reuters):

“An a la carte regime would enable viewers to buy their television channels individually, in smaller bundles, or in the large bundles currently offered,”

The way cable rates are set has little to do with the consumers of entertainment content, which is why we seem to have progressed from 57 channels to several hundred… and still nuthin’ on. We each pay for a package of channels that includes one or two we’d like to have and dozens we don’t care about. Meanwhile, some of these programmers pay the cable company for distribution while others get paid by the cable company for the right to distribute the content.

According to the Reuters article, “cable operators have been reluctant to allow customers to choose their own program bundles, claiming that it would raise prices for consumers.” So what? Consumers frequently trade higher prices for things they want more. The real issue is whether the cable companies would continue to get the kickbacks for certain channels, or whether the consumer would buy any channels at all if they found out the one they wanted was the only one in the 20 they were actually paying for. The article concludes:

Kyle McSlarrow, chief executive of the National Cable and Telecommunications Association, said at a press conference afterward that the industry should not be forced by government to offer networks on an a la carte basis.

Which is the real problem. Who do you trust more: the government or the cable operators. The chances are it is neither, and that is why Joost, YouTube and other options are the real threat to content providers and distributors.

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Small Cap Watch List (Track at Marketocracy).

Frankly, we were surprised at the amount of turnover in our screens. Only 9 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Still, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.

So without further ado, the names on the chopping block from the previous list are:

Silgan Holdings (SLGN - Annual Report); Steel Dynamics (STLD - Annual Report); NVR (NVR - Annual report); Middleby (MIDD); Vector Group (VCG); Sanderson Farms (SAFM); Downey Financial (DSL); Waddell & Reed (WDR); Wilshire Bancorp (WIBC); Harrington West (HWFG); Gamco Investors (GBL); Apria Healthcare (AHG); Papa John’s (PZZA); Cato Corporation (CTR); Meredith Corporation (MDP); CSG Systems (CSGS); Energy East (EAS); Dynamics Research (DRCO); Ingram Micro (IM); and Dade Behring (DADE).

The new watch list will be:

When Meredith Corporation (MDP) reported earnings, we noted:

This was slightly ahead of expectations, due in part to strong advertising trends. However, the guidance was ever so slightly below expectations. We are also concerned that circulation revenue fell (publishers get paid both for the subscriptions and the advertising.) If circulation trends are down it could lead to lower advertising rates in the future. Although the impetus for the decline was price reduction rather than lower numbers of subscribers, advertisers are usually willing to pay more to be in popular publications that can command higher subscription rates. So it could still be a concern, though it is less of one than had the actual number of subscribers declined.

Part of the reason for the price reductions was related to the acquisition of various magazine titles from Gruner+Jahr. The ongoing alignment of the businesses will also result in some one-time earnings adjustments:

Meredith Corporation said today that it will record a one-time pretax charge and realize a one-time tax benefit with the sum of these actions resulting in a net increase of $0.03 in earnings per share in its fiscal 2007 third quarter.

The one-time $13 million charge (approximately $8 million after-tax) consists of:

– Approximately $7 million (non-cash) to write off the assets of Child
magazine which will transition from a print to an online brand
exclusively within Meredith’s soon to debut parenthood portal. Most
of this charge is related to deferred subscription acquisition costs.

– A $3 million (non-cash) impairment charge for Meredith’s Chattanooga
television station (WFLI-TV), which is currently held for sale.

– $3 million for severance-related costs associated with approximately
60 position eliminations across the company being made today.

Also, Meredith will record a one-time tax benefit of approximately $9 million in the third quarter of fiscal 2007 due to the resolution of a tax contingency related to a loss on the sale of stock in Craftways, a business sold in fiscal 2003.

Other than the net benefit of $0.03, the company says the actions will not have a material impact on Meredith’s financial performance in fiscal 2007 or fiscal 2008. Meredith expects to report earnings per share of $0.86 to $0.87 in the third fiscal quarter of 2007 before the impact of the one-time charge and tax benefit. For all of fiscal 2007, Meredith continues to expect to report earnings per share 12 to 15 percent higher than the $2.86 earned in fiscal 2006.

We asked, but no one answered. So we are taking our own counsel and breaking our Watch List into three portfolios: Small Cap, Mid Cap and Large Cap. Each will be tracked against the relevant S&P index going forward from their collective inception date of January 31 (priced at the close of market trading that day.)

For your viewing pleasure, the Small Cap Watch List (Track at Marketocracy) (to be measured against the S&P 600) follows.

In addition, we will provide a “quick and dirty” analysis of each name, with a goal of one such analysis per day. As the name implies, the quick and dirty analysis will be incomplete. We are hoping you will join in the debate and fill the gaps in our analysis.

With our decision to move to several different Watch Lists by market cap (more on this later) we’re going to have our work cut out for us keeping track of them. While the official launches aren’t until January 31, it is earnings season and we might as well comment on the occasional one to get the ball rolling. Meredith Corp. will be a member of our Small Cap Watch List (Track at Marketocracy) and reported earnings this morning.
Meredith Corporation - Investor Relations - Financial Release

Meredith Corporation (NYSE: MDP), one of the nation’s leading media and marketing companies, today announced strong second quarter fiscal 2007 results. Earnings per share grew 24 percent to $0.72, compared to earnings per share of $0.58 in the prior year quarter. Net earnings increased 20 percent to $35 million. Revenues increased to $406 million, up 5 percent, including advertising revenue growth of 8 percent fueled by strong performance at Meredith’s television stations.The Company’s results for the quarter reflect a pretax charge of $3 million, or $0.04 per share, to reserve for a doubtful account relating to the December 29, 2006 bankruptcy filing by book distributor Advanced Marketing Services.

This was slightly ahead of expectations, due in part to strong advertising trends. However, the guidance was ever so slightly below expectations. We are also concerned that circulation revenue fell (publishers get paid both for the subscriptions and the advertising.) If circulation trends are down it could lead to lower advertising rates in the future. Although the impetus for the decline was price reduction rather than lower numbers of subscribers, advertisers are usually willing to pay more to be in popular publications that can command higher subscription rates. So it could still be a concern, though it is less of one than had the actual number of subscribers declined.

On the positive side, cash from operating activities rose by a far greater amount than either revenues or net income.

We are new to Meredith and this should not be taken as a full-fledged research report by any means. If you can add to our understanding, please do so in the comment area.

Yahoo will issue its third-quarter report on Tuesday, Oct. 17, after the close of U.S. markets, while Google reports on Thursday. What are old media benchmarks saying about the state of the ad market?
National, local and classified revenue fell in September due to weakness in the help-wanted, automotive, department store, grocery, and the consumer electronics sectors, Gannett (GCI) said.

Journal Register (JRC) noted on their conference call that “Our third quarter financial results reflected the continued soft overall advertising environment. Particularly, in our Michigan cluster as a result of the slowdown in the auto industry.”

This week we’ll see if it is old media vs. new media or if it is a general advertising slowdown.

Hiring outlook to slow in coming months - Oct. 11, 2006

Less hiring managers predict they’ll be taking on new employees in the fourth quarter, and more say they’ll be reducing the number of workers on staff, according to a survey by CareerBuilder.com.Only 37 percent of hiring managers are planning to add jobs in the upcoming quarter, down from 47 percent in June, according to the September survey.

From Media General’s (MEG) earnings release:

Help-wanted linage for the company’s three metro newspapers declined 11.2 percent and revenue decreased by 8.1 percent.

Of course, the employment report has shown signs of slowing down for months now:

Maybe we should all just move to India.

Speaking to investors gathered in New York for a conference sponsored by Goldman Sachs, (Yahoo! CFO Sue) Decker said weak sales of online automotive and financial ads during the last three to four weeks will cause the Internet giant’s revenue to “come in at the bottom half” of the $1.11 billion to $1.22 billion range Yahoo forecast in July. (MarketWatch)

We started getting a whiff of this possibility on June 26 when Valassis warned. As we said then:

The company attributed this shortfall to continued softness in Free-standing Insert and Neighborhood Targeted page volumes. Both segments are also experiencing pricing pressure.

Targeted ads and inserts are both areas that could be suffering at the hands of on-line advertising outlets, as the new media version may simply be more effective at reaching targeted consumers than the old. Proponents of this theory could point to the pricing pressure and infer that some of it may be due to the new options available to advertisers. This secular story is well known, and the ongoing shift of marketing dollars from newspapers and television into the Internet is a major contributor to Google’s share price.

Of course, the other side of the argument is that ad-driven business models are all highly cyclical and consumer dependent. With the consumer up to its eyeballs in debt and the housing market slowing, consumer cyclicals may be due for a slowdown. In this case, which is supported by the softness in volume, all ad-driven business models could suffer - Google included.

We brought up the potential link again on July 13 when Journal Register missed earnings.

Profits for newspaper publisher Journal Register Co., were down for the quarter ended June 25, largely because of weak advertising revenues in Michigan and Ohio. The company announced profits Thursday of $9.8 million or 25 cents per share, including a one-time charge of $2.5 million.

The fact that the worst of the slowdown is in Big Three Auto territory is telling but not surprising.
Now it’s Yahoo’s turn. Once again, the culprit is auto ads. This is officially not old media losing market share, but a full-fledged consumer slowdown-driven decline in advertising. The thing is, Yahoo! and Google have higher multiples that will come down along with the earnings estimates.