Fairfax is now so cheap it’s a screaming buy. That’s investment bank Merrill Lynch’s latest take on the media group.
Or, to put it another way, after helping to talk down the prospects for the media sector, analysts at Merrill Lynch now reckon the doom and gloom for Fairfax has gone too far.
So the upshot is: Fairfax has found a friend.
Which is handy considering the way the shares have slid. They finished at $2.82 yesterday after touching a low recently of $2.71.
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That’s not the best of backdrops for the Fairfax board’s Canberra visit where they had dinner with the Prime Minister last night and lunch today with Mr Five cents a litre, Brendan Nelson.
There have been fears of the economic slowdown hurting ad revenues (which we have already seen with employment ads) and concerns about a margin loan that John B Fairfax took over his company’s 14% stake in Fairfax to finance the buyout of other family members. Fairfax’s extensive New Zealand media interests are also under pressure as the economy in that country slows, with employment and real estate ads dropping sharply.
The slide in the ratings for Big Brother on the Ten Network also poses problems for Fairfax. Its TV production and distribution arm, Southern Star, owns 49% of Endemol Southern Star which produces BB for Ten. On current indications the series will only reappear next with another cut in its still expensive budget, which will lower returns to Southern Star and Fairfax.
As well, there’s been a talking campaign against current chairman Ron Walker and CEO David Kirk with John B Fairfax and Deputy CEO Brian McCarthy (the trusted former CEO of Rural Press) favoured to replace them.
“Whilst we remain of the view that the media sector is unlikely to outperform over the next 6 months, we firmly believe that Fairfax offers very attractive value at current prices for longer-term investors with a 1-2 year time horizon,” Merrill Lynch wrote to clients overnight.
The “current share price implies a severe recession” and ” based on our forecasts, we would have to assume a -12% decline in Australian publishing ad revenues in FY09 to generate a valuation close to the current $2.80/sh share price, which would result in FY09 EPS declining by –18%. In the absence of a major recession, we think this kind of outcome is highly unlikely.”
Merrill Lynch continued:
We remain confident Fairfax can grow FY09 earnings. Fairfax’s asset mix is much more resilient than in FY01, with the Regional and Communities now contributing 25% of group EBITDA and Online 12%, with the metros just 20%. The company’s cost base is also very well placed looking into FY09, with at least $25m Rural Press synergies expected, $5m radio synergies, a 6% decline in newsprint costs and further scope for management to reduce costs if revenues come under pressure.
The stock is cheap on every metric we look at. Fairfax is now trading: (1) 33% below our blended valuation of $4.15/sh (one-year out DCF and FY09E EBITDA SOTP), (2) in line with the US average 12-mth forward EV/EBITDA of 6.9x, and is now below publishers such as the NY Times (8.1x) and Lee Enterprises (7.2x), (3) below book value of $3.27/sh for the first time, and (4) on its highest ever yield of 7.9% FY09E. Note even under our “recession” bear case scenario (i.e. EPS and DPS decline by -18% in FY09E), the stock would still be trading on a yield of 6.3%.