Stockwatch: Cheap and sensitive to turnaround

Should you ever invest in stocks whose revenue trend is down? Benjamin Graham, the 20th Century dean of value investing, devoted a section of his classic The Intelligent Investor to doing just that, although historic US case studies can be tricky to apply here.

A London-listed example is Trinity Mirror, a £325 million media stock whose five-year record shows a persistent decline in revenues, albeit with earnings improving since 2014 amid cost cuts.

From Spring 2011 to early 2014 the stock nearly ten-bagged from 25p, mainly because the market had rated Trinity for financial distress, considering its debts and pension obligations.

But cash flow strengths were overlooked, which is why I drew attention in May 2011 at 50p on just twice forward earnings, with the 2010 results showing a 17% rise in operating profit to £123.3 million and management asserting "strong cash generation with net debt falling".

The pension deficit had also been slashed by £136 million to £161 million. With growing interest in turnaround and cyclical stocks through 2013, Trinity gained momentum, yet set itself up for a fall given its underlying revenues were still in decline.

Thus a volatile downwards trend from 235p to 112p has followed over the last two years as further costs have been cut and cash flows from newspapers applied partly to develop a new digital audience to better convince advertisers.

That investors remain unconvinced is shown by a forward price/earnings (PE) multiple just over three times and a 5% dividend yield amply covered five times by projected earnings.

Media substance if still in overall decline

Print titles range from nationals The Daily Mirror and Sunday Mirror, The People and Scottish Daily Record, to regionals such as the Manchester Evening News, Bristol Post and Liverpool Echo.

Moving from 20% to full ownership of Local World added 83 titles, making Trinity the UK's largest regional newspaper publisher, and the group has some 100 news, sport and showbiz websites attracting over 120 million browsers monthly.

With print still dominant, the 2015 results saw revenue down 7.1% to £706.5 million, albeit with operating profit up 2.5% to £107.1 million and by 7.4% to £98.7 million at the pre-tax level - which is substantial, relative to a market capitalisation of £325 million.

Operating cash flow of £91.1 million was applied largely to cut debt and a recent update for four months' trading to 1 May cited net debt down 31.2% to £64 million in this period alone, relative to £220 million about four years ago. Civil claims for phone hacking drag on, but management says it will not distract from its growth strategy. So the business has stabilised financially.

Yet, at 116p, the stock is barely responding after group revenue fell 8.6% during the first four months of 2016, albeit with "an improved rate of decline" of 6.4% in April relative to 9.3% for January to March.

Print revenues declined by 10.9% while digital rose 15.7% - although the latter is, relatively, smaller, making percentage growth arithmetically easier. Within this, print advertising fell by 19.0% and circulation by 4.5% with a slight mitigating effect in April.

More positively, the digital audience across publishing sites rose by 22% to 755 million; last year's digital launch of Belfast Live achieved a monthly audience over one million browsers within five months; this was followed by Dublin Live and Glasgow Live to provide news, weather, traffic and lifestyle listings - and hopefully a more attractive package for advertisers.

Meanwhile, a new mobile app enables switching between different news stories with opposing views say on politics or sport, co-funded by Google.

National newspaper launch flops

Not helping sentiment was Trinity's decision to launch a national newspaper, The New Day, during the period, which closed on 6 May after just nine weeks. It's been reported how Trinity's AGM heard questions over "secretive" costs of a £5 million failure, but best see what the accounts prove.

The aim was creating an audience which does not generally buy newspapers, an odd priority for a smaller media group with plenty happening in digital.

It begs a question over chief executive Simon Fox, ex-HMV Group, who has ripped out costs but (as one wondered at his appointment in September 2012) does not have a track record of flair for media. His remuneration rose from £1.7 million in 2014 to £2.4 million last year.

Analyst targets range from 140p to 298p

Yet brokers are optimistic with targets generally much higher than the 116p share price.

Admittedly, Barclays continues to downgrade, from 160p to 140p - likewise Panmure Gordon from 240p to 185p - while other targets range up to 298p from Numis (company broker). Liberum Capital has kept its 275p target after the latest trading update.

Implicitly, these optimists assume Trinity's earnings will get rated better in time; meanwhile the stock's pricing for a 5% yield is fair compensation for the risks. As debt gets further eroded away it is possible more earnings get distributed, helping re-rate the stock unless revenue persists materially down.

Not to jump the gun, but it's worth noting how supermarket Morrisons has recently shown it only needs confidence in a reduction in the rate of revenue decline to drive a stock higher. Trinity is in low PE territory and offers significant yield, hence is likely sensitive to any positive change.

Mind that its balance sheet involves £800 million in intangible assets, hence the persistent negative net tangible assets per share, whereas Morrisons enjoys strong asset backing through property. So the focus at Trinity is very much on revenue as a leading indicator.

While a turnaround obviously isn't defined in a month, April's relative improvement makes Trinity more interesting. Last year there was a 26 June update ahead of interims on 3 August, so if you appreciate the gamble then consider accumulating beforehand.

For more information see their website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.