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Torstar: What bargain hunters don't see 00:00 EST Friday, February 29, 2008

If you're looking for the perfect antidote to a cheerful disposition try a dose of Torstar's Management Discussion & Analysis.

It's such a relentless litany of gloom you have to wonder why value investors are loading up on the shares. Could there be some hidden nugget of information that makes this company attractive? If so, it's not obvious.

Torstar's shares are languishing at multiyear lows, fetch 13 times earnings and yield 4.3 per cent.

That's the sketch of a value stock. But start filling in the colours and it doesn't look rosy. The point of buying equities is capital appreciation. For that you need rising profits.

Torstar divides its business in two divisions: the first is called Newspapers and Digital, and includes the Toronto Star newspaper; the second is called book publishing, and includes the well-known romance novel publisher Harlequin. Other than these two operating segments, Torstar also has passive investments in CTVglobemedia, which owns the CTV network and the paper you're reading, and Black Press, a small-market newspaper publisher.

A quick look at Torstar's annual financials might excite the bargain hunter. Total revenue was up a little more than 1 per cent in 2007. But the operating profit was up 32 per cent, and earnings per share rose by almost as much. EBITDA (earnings before interest, taxes, depreciation and amortization), which tends to give cleaner indication of performance, was also up, by 11.5 per cent.

So far so good. But scratch a little and you have to start wondering if Torstar isn't a trap. Let's start with that increase in EBITDA. In the newspaper and digital business, EBITDA was $21.8-million higher in 2007. But lower newsprint prices added $14-million. Given all the consolidation in newsprint production and mill closings, if anything, newsprint is going to get more expensive. There was also a $4.5-million improvement because Torstar shut down a money-losing magazine in 2006. Finally, lower expenses at the struggling Transit TV (which puts ads in buses and trains) added $2.5-million.

In other words, there was no growth in profits. And yet segment revenues were up $27-million.

You have to wonder about the brand value too. Star Media, the unit that includes the flagship Toronto Star and is a part of the newspaper division, posted revenue of $504-million last year, a modest increase. But the Star's revenue was down while digital revenue was up. Is that a problem? Let's lean on the MD&A to see: "The competitive environment [for digital] continues to change at a rapid pace, there are lower barriers to entry, and the competitors range from start-up operations with low cost structures to global players with access to greater financial and other resources than Torstar."

Sounds like the flagship's brand value might be overstated. The numbers make the case: Star Media had operating profit margins of 5.7 per cent.

On the other hand, the lowly Metroland Media unit, which produces a few dailies in Southern Ontario and some small weeklies and specialty publications in the Toronto area is a cash cow, earning almost 20 cents for every dollar of sales. But there are problems there too, which we'll address in a minute.

As for book publishing, it's no great shakes. The segment's numbers improved a little year over year but the true bottom line is that it sold fewer books.

So what do the value buyers see? Maybe it's what they don't see. They certainly don't know how much or how fast this business will decline, but decline it will, even the community newspapers.

Talk to someone who runs a small business and who has advertised in print and online with Google or Yahoo. I did, and I also spent an hour with Google this week to learn about its ad technology.

It's like a smart bomb, allowing advertisers to narrow in on the most specific of markets (including the ability to target an area within a radius of your business). That's what small companies want. Two smallish ads in a mid-market big city paper cost my acquaintance the same as a month of Google ads, which paid off much more.

At some price, even a declining business has some value. But before you follow in the footsteps of the big-name value investors buying Torstar, talk to its customers. They might talk you out of it.