Paul Hill, share tips

Share tip of the week: a lesson in diversification

07.12.2007

by Paul Hill

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Whilst this media group may be best known for its flagship newspaper, the majority of its operating profits are derived from its other interests, including magazine's and websites. Paul Hill believes that the strength of its core titles along with its smart diversification strategy should help it through tougher times in the sector:

Daily Mail & General Trust (DMGT), rated a BUY by Goldman Sachs

On 21 November, Daily Mail & General Trust, owner of the Daily Mail and the Evening Standard, delivered a robust set of full-year results. On an underlying basis, 2006/2007 turnover was up 3% to £2.2bn, while earnings per share (EPS) and the dividend rose by 6% and 10% respectively to 49.3p and 14.35p per share

In these days of tighter liquidity, the group made healthy operating cash flows of £313m, despite investment in its newly-completed Didcot printworks and a £26m top-up of its pension scheme, which is now believed to be in surplus.

As well as its national and regional titles, the group is active in TV, radio, teletext, magazines, exhibitions and book publishing. It also owns several websites, such as Findaproperty.com and Femail.co.uk. In fact, 53% of operating profits are now derived from non-newspaper interests.

So why did the shares drop 9% on the day of the update to 525p – the lowest in four and a half years? This seems all the more surprising, given that afterwards, in a show of confidence, the chairman, outgoing chief executive, financial director and property director bought £433,000 worth of shares between them at prices between 529p and 549p.

Well, after £389m worth of acquisitions last year – including the £187m purchase of Metal Bulletin (an information and events company focused on the financial and metals markets) – net debt rose from £738m to £950m. This doesn’t seem a big problem, as interest and dividend payments are covered 3.4 and 5.6 times.

But the City is worried that if advertising markets soften as the economy slows, this could squeeze liquidity. And at the analysts’ presentation, the group painted a cautious outlook for 2007/2008, saying that although the board was “optimistic about achieving another year of steady growth in earnings”, this would depend on “the UK economy not deteriorating substantially”.

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This is a sensible approach, given existing volatility and lack of visibility post-Christmas, but I suspect this prudence has been overplayed. With the incoming chief executive now known, I believe the board is quietly confident of beating revised expectations, particularly as the finance director, Peter Williams, added that it would be “delightful to prove the doubters wrong”.

If I’m right, the City is underestimating Daily Mail & General Trust’s prospects. Its leading newspapers seem to be outperforming in terms of revenue growth, while the cover price of the Daily Mail has scope for further rises, especially as its readership is considered “incredibly loyal”. Analysts forecast sales and underlying EPS of £2.3bn and 53.3p respectively for this year, putting the shares on a p/e ratio of 10.5.

Fine – but what are the risks? The main fear is the cyclical nature of the advertising industry in the event of a severe recession. There is also concern about the sustainability of revenue growth within its information unit, where it publishes data for the property, insurance, financial services, energy trading, and education markets.

Yet with the stock trading at attractive levels, I believe the shares have been unfairly marked down, and the strategic value of the group’s national titles should help underpin any continued short-term weakness.

Recommendation: BUY at 540p

Paul Hill also runs a highly successful share-tipping service; click here to find out more: Precision Guided Investments.