In light of the present acute nervousness on the equity markets, here’s a relatively defensive “old economy” stock as the Tip of the Week. With market sentiment still on a knife-edge, I believe this type of firm will outperform in the event of another nose-dive in confidence.
Tip of the week: Smiths News (NWS), rated as outperform by Seymour Pierce
Smiths News (SN) was formed from the demerger of WH Smith on 1 September last year. It is the UK’s leading newspaper (40% market share) and magazine (35% share) wholesaler. Smiths News handles over 59 million journals each week, serving retail outlets from small newsagents and convenience stores to supermarkets and garages. It operates 24 hours a day, 364 days a year from 44 distribution centres and employs around 4,200 staff. As most items are sold on a sale-or-return basis, Smiths News also deals with the collection of around 11 million unsold journals each week. This is a complex and time-sensitive operation that creates substantial barriers to entry.
Within the overall industry, newspaper volumes have been decreasing since the 1980s because of changing consumer habits and the availability of more television channels and the internet. However, this gradual decline has been more than offset by cover-price increases, resulting in a relatively stable – albeit competitive – market.
This is important since it provides good earnings visibility for firms such as Smiths News. Around 70% of Smiths News’s turnover comes directly from retail sales value (the cover price multiplied by volume), with the rest largely dependent on volumes. To make distribution more efficient and avoid duplication, publishers typically enter into long-term supply agreements (around five years) with Smiths News. Currently, these contracts (subject to the outcome of a pending Office of Fair Trading (OFT) investigation) provide exclusivity in pre-determined geographic areas.
Fine, but how is the business doing? Last week, Smiths News released a pre-close update, saying that trading for the year ending August 2007 was “in line with expectations”. Newspaper revenues were up; magazine sales were flat. Analysts expect 2007 sales and underlying earnings per share (EPS) of £1.25bn and 13.6p respectively, putting the shares on an undemanding p/e ratio of 10.7. A 6.5p dividend is also expected, giving a chunky 4.4% yield. Net debt stood at a comfortable £64m in February, on top of a pension deficit of £21m.
This looks good value in light of Smiths News’s defensive qualities. Going forward, there are also opportunities to leverage Smiths News’s excellent distribution network in other areas – for instance, meeting online orders. With the internet becoming ever more important, retailers need rapid and reliable delivery of their goods. As such, Smiths News may well benefit from this expanding demand, particularly as the UK’s postal networks have recently been opened up to greater competition.
So far so good, but what do we need to watch out for? Undoubtedly, the biggest question-mark is the OFT report (expected later this year) on the future structure of the industry, in particular the status of the territorial exclusivity contracts between wholesalers and publishers. Even so, as the top player with leading technology, Smiths News is well placed to respond to any change in the status quo. Finally, even if Smiths News is unable to find new markets for its leading distribution capabilities, I could readily see a third party buying the business to acquire this attractive asset. Full-year results are due out on 18 October.
Recommendation: Long-term BUY at 142p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments