Smiths News — Refinancing releases dividend shackles

Smiths News traded well in H124, outperforming the underlying revenue trends, with the year-on-year decline in revenue and profit largely attributed to the exclusion of one-offs in the latest period. However, there are two items of real news. Firstly, the company has refinanced its debt facilities, which not only produces interest cost savings, but also removes the cap on dividend payments. Secondly, the organic business is expanding rapidly and is expected to generate a profit contribution of c £2m in the current year, with management expecting that further growth is likely. Furthermore, there has been a tweak to the capital allocation policy, which should foster growth and maintain balance sheet discipline. Our full year forecasts are largely unchanged but we have materially lifted our dividend forecast. Our valuation is nudged up from 89p to 90p.

H124 revenue slipped c 2% to £539.8m, which was primarily accounted for by the inclusion of revenue generated from the men’s football World Cup and the Royal Succession in the comparable period. Smiths’ core news and magazine revenue also outperformed the structural decline, which is typically c 3–5% pa, as there were a number of cover price rises in the period. Operating profit reduced 7.8% or £1.8m to £18.8m, reflecting the one-shot revenue mentioned above, and also pricing pressure in magazine waste volumes. As ever, these pressures were offset by the well-rehearsed annual efficiency savings that target c £4–5m pa.

Adjusted EPS declined 12.5% to 4.9p, but the company increased the interim dividend by 25% to 1.75p following the removal of restrictions relating to the previous banking arrangements. Smiths News intends to have a twice covered dividend paid out one-third/two-thirds in H1 and H2. Net debt at the half year fell 56% to £10m, while average net debt fell 52.5% to £12.5m.

In the period, newspaper revenues increased 0.1% despite the ongoing volume decline due to the inclusion of new contracts with News UK and the Midlands News Association won in October 2023, and from some cover price increases. Magazine revenue was down 5%, in line with historical trends, and again, cover price increases partly offset volume declines. Revenue from collectables, excluding the World Cup and the Royal Succession mentioned above, were up by c 5% reflecting a better performance from the Premier League football collections and a first sticker collection from the Women’s Super League.

The two new long-term contract wins with News UK and the Midlands News Association imply that c 74% of revenue is now contracted to 2029. Other contracts are due to expire in the foreseeable future and, if renewed, which is the likely outcome, the percentage of revenue contracted to 2029 and beyond is likely to increase, further improving the visibility of revenue.

Smiths News’ previous banking arrangements reflected the elevated net debt levels from M&A, which saw its net bank debt to EBITDA ratio stand at c 3x in 2020. These arrangements were due to mature in August 2025 and importantly contained a dividend distribution limit of £10m pa. Since 2020, cash generated in the business and disposals have seen the net debt level fall to below £10m, and we expect net debt to continue this trend in FY25 and beyond.

Alongside the interim results, Smiths News announced that it has renegotiated its financing in a favourable way to both the company and shareholders. This includes a modest increase in total potential facilities, from £46.5m to £50m, a three-year term with two one-year extension options and a reduction in the margin from 4.0% to 2.45%, implying a material cost saving.

Furthermore, the £10m dividend distribution limit has been removed, which has allowed the company to increase its interim dividend by 25% to 1.75p, and allowed us the freedom to increase our full year dividend expectation from 4.2p to 4.9p. This implies a very attractive dividend yield of 8.6%.

Now the refinancing is complete and the dividend restrictions have been removed, Smiths News has revised its capital allocation policy, which is designed to promote investment in the business, provide scope for potential bolt-on acquisitions and reward shareholders.

In summary, the revised plan is as follows:

The maintenance of a strong balance sheet is likely to limit the scale of any bolt-on acquisitions. The demonstration of clear value accretion in any future deal will be a key focus for shareholders.

In November 2022, Smiths News outlined its ambition to better utilise its distribution network to generate new profit streams to offset the anticipated annual decline in newspaper and magazine distribution volumes. We believe this makes practical and commercial sense considering that its 36 depots in the UK are idle for long periods each day, and that its vans are visiting each of the company’s 19,000 customers every day.

In 2023, Smiths News successfully trialled a cardboard and plastic recycling collection service in Birmingham. The service included the collection of unwanted cardboard and plastics at the same time as dropping off the day’s newspaper and magazine delivery. Smiths News now has c 5,000 subscribers, a number that has more than doubled in the last 12 months. We anticipate that the service might be suitable for c 30% of its addressable customer base, and could also be attractive to other adjacent businesses such as betting shops.

Smiths has trialled other categories including the distribution of greetings cards in point-of-sale stands, DVDs and books to major retailers and some supermarkets. The product is delivered to Smiths in bulk where it breaks the supply down, picks, packs and handles returns, playing to the company’s core strengths. There are potentially other products and/or customers where this kind of service may offer value to clients, and income and a profit contribution to Smiths News, which could offset the expected decline in the core business. These are being actively explored.

The new business streams are potentially significant. Last year, these initiatives generated £0.7m of operating profit. In FY24, the company is anticipating that it will generate a profit contribution of c £2.0m. Ultimately, these new income streams are likely to grow further. It remains to be seen if they can be scaled sufficiently to completely offset the decline of the core business, but so far there is optimism.

Following the interims and the company’s in line outlook statement, we see no reason at this stage to revise our profit estimates. However, the new refinancing arrangements, which do not contain any restrictions on dividend payments, give rise to higher shareholder payments, hence the material increase in the DPS payments in the table below. The company is also budgeting for increased capex spending, which collectively account for the change in net debt.

Our discounted cash flow (DCF) valuation remains broadly unchanged at 90p/share (from 89p), representing c 40% upside to the current share price. Smiths News trades on a P/E of 6.2x in FY24e, with a yield of 7.7% and the prospect of special dividends to bolster the yield as debt falls. In our experience, when ‘safe’ dividend yields exceed P/E ratios in absolute terms, it indicates a value opportunity.

Although we currently forecast a consistent revenue decline, the early signs of success with the new business initiatives suggest that the associated profit decline may be less than we currently forecast, implying that profit and valuation risks could ultimately be to the upside. The success or otherwise of these new business streams is likely to become clearer in the next two to three years.

The low P/E rating might be explained by market expectations of continued revenue declines. Our DCF valuation assumes a 5% pa revenue reduction. A full explanation of our assumptions can be found in our November 2022 update note.