Stockwatch: Ultra-low PE and 5% yield a value trap?

Is the £340 million FTSE Small-cap media group Trinity Mirror gaining traction as a turnaround, and can it overcome the poor print media industry?

Its story has moved on from May 2011 when I drew attention to the stock at 50p, as I believed Trinity's strong cash generation would overcome market fears of financial distress. The stock then rose as high as 234p in the following three years, but this became a volatile downtrend and 74p was visited briefly around last June's EU referendum.

The key question today is whether Trinity Mirror's expansion of its UK media title portfolio can offset the continued decline in national print media/advertising, hence avoiding a value trap.

2016 better than expected

Normalised pre-tax profit of £133 million compares with a £131 million consensus from two brokers and normalised earnings per share (EPS) of 38.1p versus roughly 36.8p targeted. This is substantive relative to market capitalisation and a 13.1% operating margin is respectable.

But it isn't organic progress: while statutory group revenue rose 20.3%, like-for-like revenue fell 8.0% reflecting ongoing challenges to national print media and advertising.

Growth figures reflect the October 2015 acquisition of the 80% of Local World media that Trinity didn't already own from the Daily Mail publishers. Its integration has beaten expectations, achieving £10 million of synergy savings with £15 million targeted for 2017. Moreover, a tight control over group costs pushed overall savings to £25 million.

This is good, but Trinity will need to keep applying cash flow strengths intelligently for corporate development, as cost-cutting on existing and newly-acquired assets can only go so far. Key aspects of risk/reward are, therefore, whether management can find decent targets and those already owned don't just drag results down.

Ultra-low PE and 5% yield

Not surprisingly then, the market has applied a very low annual average price/earnings (PE) multiple to Trinity Mirror, and exacted a dividend yield near 5% to help compensate for holding risks.

Care is needed with "consensus" forecasts: Peel Hunt's 2017 numbers dated 20 May 2016 anticipate £136 million pre-tax profit for 38.3p EPS and a 9p dividend. Last December Numis published lower projections of £115 million, 32.3p and 5.7p respectively. Both are cited as having commercial relations with Trinity.

Frankly, projections are guess: the company's own outlook statement cites a 9% like-for-like drop in revenue for the first two months of 2017, affected by changes in its business mix. "Print markets, in particular advertising revenue trends, are expected to remain challenging and volatile during 2017 while digital audience and revenue is expected to continue to grow," the group said.

Publishing digital revenue grew by 12.8% to £78.5 million in 2016, although within this digital classified revenue fell by 11.3%. So, digital is no panacea and Trinity's overall 2017 performance outlook will reflect how resilient consumer spending proves amid higher inflation and Brexit being initiated from end-March.

It's also possible to see such risks as priced into the stock, if it can achieve modest dividend growth. 2016 saw a 50% jump in 2016 net cash inflow from operations to £79.3 million. With £37.8 million cash-at-bank the dividend assumptions behind a 5% yield look under-pinned. The company could also steady its £10 million share buyback programme if trading turns down seriously to compromise cash flow.

Pension deficit swells 53%

It's swelling pension defecit is the chief reason the stock dipped straight after results. Indeed, a third declared risk remains that "pension deficits grow at such a rate so as to affect group viability or so that annual funding costs consume a disproportionate level of cash flow."

The results statement blames Brexit for reducing gilt and bond yields although it doesn't mention the counter-balancing factor that it would only take marginal increases in interest rates to bring down the accounting deficit. The realistic impact may not be as great as the latest accounts imply, if UK interest rates have bottomed out. £40.7 million was paid into the pension scheme during 2016, just over twice that in 2015.

Another twist in liabilities has been the Mirror phone-hacking scandal, sanitised in these results as "historical legal issues" where damages for over 80% of claims had been settled by the year-end, the remaining provision being £18.1 million which looks plenty manageable in cash flow context.

Yet, despite all this, the cash flow statement shows £80.0 million applied for repayment of borrowings (net debt is down to £30.5 million) and £14.6 million on dividends, thus Trinity has been able to tidy up moderately and support a useful yield.

Share buybacks - see relentless RNS news - mean the company holds just over 3.3 million in treasury versus 280.1 million issued, which should help modestly enhance EPS.

Mind, there remains a lack of tangible asset backing, the balance sheet loaded with £799.5 million intangibles and £102.0 million goodwill, which together with the £466.0 million pension deficit raises negative net tangible assets per share from 77.9p to 115.0p.

Raising eyebrows

Trinity is, therefore, a right stir of factors to raise eyebrows, although the chief question for longer-term value is the extent chief executive Simon Fox can repeat acquisitions like Local World, as a consolidator of challenged media.

Local World has contributed £220 million of value on a debt/cash-free basis - about two-thirds of Trinity's current market value - and shows Trinity capable of such purchases given its strong cash flow credentials. A modest £80 million new debt has already reduced and £35.4 million worth of shares issued at 158p were entered into as financial top-up to complete the move.

Fox declared on the Radio Four Today programme that Trinity is on the look-out for both national and regional titles, and speculation was confirmed in January that talks have been renewed with Express Newspapers – one aim being for significant savings from merging back office and sales operations.

Fox didn't win any points with investors who backed him as chief executive of HMV Group, but the Local World deal is (so far) shown as realistically astute.

Economic slowdown would make more media titles available for acquisition and cost-cutting, so if Trinity can find and integrate good ones then its risk/reward profile can tilt positively, hence the stock as a 'buy' in terms of industry consolidator. The chief risk being ongoing decline in like-for-like revenue growth.

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