I first blogged about Smiths News almost a year ago, and saw on Twitter that they'd released an interim statement today. Having read it, it seems they've really done rather well over the last year since I first looked at them, so they definitely warrant a second look. What interested me then is exactly what interests me now - they're the larger firm in a tight duopoly. Additionally, in a situation where this might not be a huge disadvantage, they're in that competitive position in a slowly declining market. If you want to deter competitors, being one of two dominant firms in an industry with an uncertain future seems a good way of doing it.
That industry, of course, is distribution - newspapers and magazines mostly, though they're diversifying into books and more niche markets like education. News is still by far the largest segment, and contributes the most to operating profit. The obvious danger, of course, is that a cash cow is being milked in the wrong way. There is clearly a temptation on the part of directors to prefer to diversify and try to create a long-term business model in other distribution segments, rather than simply wind down the news division and pay out the copious cash flow to investors. Which one is the right thing to do? That's a little more difficult to decide. How easily transferable are these distribution skills that Smiths News has acquired? To note - both new divisions are earning better margins than News, on much smaller revenue. Is that question already being answered?
Putting the cart before the horse
There is one more fundamental difference between investing in Smiths News in 2012 and investing in Smiths news today, though, and one that does do quite something to put me off. Look at the graph below:
The fact is that the company is considerably more expensive than it was when I first looked at it. It's gone from around 90p to 157p today - and given about 7p of dividends, if I'd bought then I would've made about 82% on my capital in that timeframe. That's not to say it's by any means a poor investment now - I think it's a terrible fallacy (though one I'm definitely not immune to) to look at a stock that's gone up considerably and conclude that it must now be fairly priced, simply because it's risen lots. More even-handedly, though, it is fair to say that if I was ambivalent on it the first time, an 82% rise should probably make it expensive in my books - unless there's something fundamentally different about the company.
Some things have changed. The forecasts have, for instance, been revised up significantly. The outlook for the company - in the form of this interim statement - is broadly positive. The macroeconomic outlook in general feels less gloomy than it did then, too. And those revised forecasts, the management thinks, will be met - note the forward P/E in my box, top right, of 7.4. That's low by most standards.
It takes two to tango
There's a more obvious change, though, and that's in my perception of the company. This is always a dangerous one to discuss, because it's extremely prone to 20/20 hindsight, but I certainly think that if I were to take myself now and zip back to when I was writing that first post, I would have been far more positive than I was. In retrospect, I think at 90p the company was clearly undervalued.
It has a 55% market share. The company requires a tiny amount of capital to run, owing to the fact it can basically use payables as a free source of working capital. Management were confident - and they continue to be, increasing the dividend further. I think those questions about uses of cash - whether all this diversification will really pay off for the company - are pertinent. I also think the £170m market cap it was trading on discounts those worries quite nicely.
Still, dwelling on the past doesn't do much good. Instead, I ask myself the question again - is it cheap?
Should I buy?
I'll be boring and say my best guess is that it's fairly valued, with an expectation of being wrong. The trouble is the uncertainty of the future, and the fact that the cashflows from that news segment certainly aren't indefinite - it's an operation which scales extremely well (hence the natural duopoly state) but, likewise, that means a contraction cuts straight into margin without much coming off costs. Profits are still going up, but the diversification plans add risk to an already uncertain proposition. The company is in negative equity, and so the entire value of the company is in the great returns on capital and the future cashflows - but those, as I've just mentioned, are subject to debate.
With a total EV of something like £370m and pre-exceptional operating profit last year of around ~£50m, it's really all a matter of time and timing.