This supplier of directory services may have come under pressure from new startups in the markets. But prospects remain strong nonetheless, says Paul Hill.
Gamble of the week: Yell Group (YELL)
Yell offers classified advertising primarily to small firms, along with telephone directory services, such the UK’s 118 247. Its main printed products are the Yellow Pages and Business Pages in the UK and the Yellow Book in America. Typically, these books have generated stable yet slowly decreasing revenues due to advertisers reallocating part of their marketing budgets to the internet. Yet overall this trend has benefited Yell because it has driven huge demand for its online websites, Yell.com (UK) and Yellowbook.com (US). In the first-quarter of 2007, the group generated credible top-line growth of 3.9%. UK revenues from printed directories fell as expected by 3% to £138m, but this was offset by Yell.com’s 54% increase to £31m. This achievement was repeated in the US, suggesting Yell’s online presence will compensate for the decline in print-based advertising.
So what led to the company’s profits warning in April? Well, the problem was a slowdown in the US (accounting for 42% of sales) because of increased competition, particularly from new startups in the directories market. This means that US sales growth is set to be only 3% in 2007, as opposed to 10% last year. However, the board believes that many of these rivals are now struggling, especially as their funding will be further stretched by the recent credit crunch. If this assumption proves correct, Yell’s US performance should significantly improve in 2008 and beyond.
Prospects in the UK also look better. The weak figures from UK print directories were partly down to the affect of price controls. Historically, the industry regulator has put a price cap on the rates that Yellow Pages can charge advertisers. As the cap increase is set at inflation minus 6%, Yell has effectively had to cut prices each year. But from next April these restrictions will be relaxed, at which point advertising rates can be raised by inflation and differential pricing adopted for the first time – an opportunity to boost earnings. The City predicts sales and underlying earnings per share of £2.2bn and 37.5p this year, rising to £2.3bn and 42.5p for the year ending March 2009. So this relatively defensive stock is trading on corresponding p/e ratios of 12.1 and 11.1 and paying a 4% dividend yield, which looks cheap. On 24 July CFO John Davis reiterated the board’s confidence in the full-year guidance.
Key risks include a further devaluation in the dollar, together with the group’s £3.6bn net debt, where interest payments are covered a manageable, but tight, 2.75 times. Further out, there are worries of greater competition from the likes of Craigslist.org and Google, but for the time being the shares rate as a higher-risk buy.
Recommendation: for more adventurous investors, BUY at 448p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments