Smiths News — Better FY22 than expected; 10% dividend yield

Despite ongoing market headwinds, Smiths News reported resilient FY22 results, with revenues down 1.8%, below the average pre-COVID annual decline (2015–20) of 3–5%. Adjusted operating profit dropped marginally by 3.8%, which excludes provisioning of £4.4m to cover bad debt risk following the collapse of McColl’s. In addition to the progressive actions taken by management, a rise in high-margin, one-shot and collectable sales helped offset inflationary pressures, with revenues in these categories up 43% y-o-y. The company has seen continued demand in these categories so far in Q123, which is encouraging. We have raised our forecasts to reflect better than expected trading while acknowledging that inflationary pressures exist in the market. However, on the back of increasing the applied risk-free rate, we have decreased our valuation from 94p to 89p, which is still over 100% upside to the current share price.

FY22 revenue of £1,089.3m represented a decline of only 1.8% y-o-y, lower than the historical pre-COVID-19 trend, with an even split between interim periods: H1 (£544.8m) and H2 (£544.5m) were down 1.2% and 2.4% y-o-y respectively. FY22 saw a strong performance from one-shot releases (+43% revenue increase y-o-y), mainly owing to Premier League football and Pokémon trading cards. Daily newspapers (-2%), and weekly (-3%) and monthly (-2%) magazines outperformed historical trends, as shown in Exhibit 1, but these robust figures were offset by a 9% decline in Sunday newspapers, where price rises were largely absent. The Dawson Media Direct (DMD) airline segment of the business saw a 27% rise in revenue to £4.2m, benefiting from normalised travel post-COVID and additional newspaper and magazine supply to Emirates and Thai Airways seen in H2.

Strength can be noted in the adjusted gross (6.7%) and operating margins (3.5%). The former rose 10bp y-o-y and is larger than the pre-COVID 2019 margin of 6.6%. In 2023 we will likely see increased one-shot revenue from the funeral of Queen Elizabeth II, the FIFA World Cup in Qatar, the coronation of King Charles III and the UEFA Nations League finals. A net debt reduction of 73% to £14.2m at YE22 presents a net debt:EBITDA ratio of 0.3x, comfortably below the company’s main leverage covenant limit of 2.75x; one-off income including the pension surplus (£8.1m) and the final settlement of Tuffnells deferred consideration (£14m) were both used to pay down debt. With rising interest rates and inflationary headwinds, lower debt levels will bolster the group’s financial position on account of the consequential lower interest charges.

The company has demonstrated its ability to successfully mitigate inflation through tight cost control and growth of ancillary revenues; the net impact of inflation was a modest £2.1m (less than 1% of revenue). Management estimates that inflation carry through to next year will be approximately £1.5m. Since October 2021, the group has benefited from fixed energy prices lasting to 2024, which represents a relatively small part of the cost base. Management has stated that it will continue to monitor when the right time is to extend the energy agreement.

The current year has started well, with contracts representing 35% of newspaper and magazine sales revenues renewed until 2029, underpinning the sustainability of the business in the long term. Since the period end, the group has announced the signing of a new newspaper distribution deal with Associated Newspapers Limited, publisher of the Daily Mail, The Mail on Sunday, ‘i’ newspaper and New Scientist. This new agreement covers all of the group’s existing territories with Associated Newspapers and represents revenue of c £155m pa at current market values.

This agreement followed the signing of new five-year magazine distribution deals with both Frontline (the UK’s largest magazine distributor) and Seymour (part of Frontline Group and the UK’s largest independent magazine distributor). These contracts cover all of Smiths News’ current distribution territories in the UK from 2025 to 2030, representing revenue of c £180m pa at current values. The two customers account for c 50% of the UK magazine market, making the deals a key endorsement of the UK magazine market and Smiths News’ position within it as the UK’s foremost route to market. Other discussions with leading UK publishers are ongoing and further agreements are expected to be announced in the next few years.

Despite current economic volatility and inflationary pressures, the combination of sustained margin mix and tight cost control provides confidence that the group will maintain its strong performance in FY23. The balance sheet has distributable reserves of £118.7m (FY21: £124.9m) to allow for future dividend payments.

Revenue for 2022 was c £12m ahead of our expectations, thus increasing the base for future years and hence the modest increase in our forecast revenue. In FY23 there is also an increased element of partworks as the funeral of Queen Elizabeth II, the World Cup in Qatar, the UEFA Nations League finals and the coronation of King Charles III fall into the period. This has led to a 5.9% increase in our FY23 total adjusted operating profit forecast to £38.1m. On the back of that, our revised FY24e adjusted operating profit has increased 8.6% to £37.8m.

We had already factored the inflationary pressures into forecasts hence we upgrade numbers rather than downgrade. These pressures include driver shortages at specific locations, higher fuel costs, contractor pressures and wage inflation. The company is no stranger to cutting costs, which it will continue to pursue through routing efficiencies and other initiatives; the overall net impact of inflation was £2.1m in 2022 and the company expects c £1.5m to roll through to next year.

We have increased PBT (reported, post-exceptionals) by 4.8% and 9.0% respectively in FY23e and FY24e, both figures above the reported £27.9m in FY22.

Net debt for FY22 came in c 30% better than we estimated at £14.2m, as the company utilised one-off income including the pension surplus of £8.1m and the final settlement of Tuffnells deferred consideration of £14m to pay it down. We have modelled further reduction in net debt to £2.6m in 2023. This implies that Smiths News’ net debt:EBITDA ratio is estimated to be 0.06x at the end FY23e, rising modesty to 0.2x at the end of the following year.

We have retained our chosen DCF method to value Smiths News. This is because the decline in revenue is relatively constant, the reduction in the cost base is also factored into management action and it has a track record of delivering. Therefore, we believe that the profits and cash flow of the company are likely to be relatively robust and to decline only slowly over an extended period of time.

Our key assumptions include:

Although we have increased forecasts marginally, the inclusion of a higher risk-free interest rate of 4% in the model (up from the previously used 1.9%) and subsequent higher WACC (9.5% versus the previous 7.5%) has resulted in a modest decrease in our valuation from 94p to 89p. The sensitivity table below shows how the valuation fluctuates with differing terminal value (TV) growth rates and WACCs. The current share price of c 42p is discounting a terminal growth rate of -10% and a WACC of 19%, both double the rates assumed in our base case scenario.