Sometimes the high-profile negatives surrounding a company can blind investors to genuine positives so that, in effect, they no longer distinguish the wood for the trees. Take Trinity Mirror, which is facing the undeniably uncomfortable structural issue that fewer people are buying newspapers these days. Furthermore, newspaper publishing is a cyclical business in the middle of a cyclical downturn.
So things are very tough indeed for Trinity and yet, despite seeing falls in both circulation and advertising revenue, the business’s profits have actually been fairly flat for the last four years as it has cut back extensively on all non-essential costs.
These actions have significantly improved cash flow, allowing trinity to address two major concerns for investors – the level of debt on its balance sheet and, not entirely unconnected, its pension fund liabilities. Over the last four years, the company has been able to reduce its debt by some 60% and, while its pension deficit remains an issue, it has made substantial strides in underpinning the fund.
One aspect of the business that does not appear to have changed dramatically, however, is Trinity’s share price. Having edged above £7 in May 2005, the shares had last summer collapsed to below 30p and, while they have come back to some degree since, they are still below the £1 mark. More striking still, the shares continue to trade on a price/earning (P/E) ratio of just 3.5x.
In the short term, advertising trends are likely to remain negative and there is little prospect of an improvement in circulation revenues. However, the question then becomes – on what multiple is all the bad news taken into account? How low must the P/E ratio go before all the negatives surrounding trinity are effectively discounted?
Very generally, the average market valuation over time is a P/E ratio of about 12x while businesses that are perceived as being in structural decline will tend to trade around mid single-digit P/Es. Not, of course, that too many businesses stay in structural decline forever – they tend either to improve their situation or go out of business.
Investors should be under no illusions – we are at the extreme sharp end of contrarianism and value management here. Trinity Mirror undeniably has significant problems but, crucially, the substantial improvements it has made to its debt pile, lead us to believe its insolvency risks have been dramatically reduced.
The company continues to pay down its debt and yet the market does not appear to be recognising that fact at all in its valuation. The powerful thing about this kind of investment story is, however, if tomorrow the market does decide Trinity Mirror’s shares ought to be rerated – even to that P/E ratio in the mid single-digits – the potential upside is enormous.