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October 17, 2005

Knight-Ridder: Cheap But No Earnings Growth

Knight Ridder (KRI) reported results in line with reduced expectations following management's lower guidance a month ago. Excluding unusual items EPS came in at 67 cents, down 18% from a year ago. Revenue was flat and shares outstanding were down about 10% so the problem in the quarter relative to its industry peers was on the cost side. The following quote from the press release summarizes the quarter quite well:

"When you strip away the complexities associated with our asset sales and acquisitions, the story of the quarter is relatively simple: Excluding the acquired newspapers, total operating revenue was up 1.1% and costs -- in a stark aberration from our normal pattern -- were up 7.0% (or 5.5% if you exclude severance costs of $8.6 million)."

The press release went on to say in relation to costs "that level of cost increase will not be repeated in the fourth quarter." On the conference call, management was emphatic that costs trends would improve dramatically in the fourth quarter, specifically guiding to 1% growth. Guidance for 4QEPS was also specific with management stating that above the year ago $1.16 was a sure thing and that current estimates of $1.25 were "in the ballpark."

KRI has almost all its exposure in major market metro dailies. This leaves the company particularly vulnerable to current industry trends where national, retail, and auto advertising are the worst performing ad categories. Furthermore, KRI's papers in Philadelphia and Kansas City are underperforming. I still don’t fully understand why these papers are lagging although Philadelphia is unusually exposed to the Federated-May merger.

To its credit, KRI management is aggressively buying back stock. Against a 77 million share count earlier this year, the company has promised to complete a 10 million share buyback no later than 1Q06. Over 6 million has already been bought as 5 million was purchased via Goldman Sachs. I think Goldman effectively shorted htose shares so in 4Q both Goldman and the company will be buying stock semeinlgy providing some downside support.

Also to its credit, KRI has been a leader in development of online properties. In 3Q05, online revenue was $1 million, representing 7% of total company advertising revenue. Online revenue grew 54% vs. 2004. Much of this revenue is a mix shift form the paper to the web and with that shift comes lower pricing on a CPM basis. Nevertheless, it is better to maintain advertisers than lose them so management is to be commended for its early focus on the internet.

Among major newspaper stocks, only Tribune (TRB) is cheaper than KRI. However, KRI has always been a cheap stock and trades at a very modest to its long-term historical valuation. So like many other stocks in the group, despite poor performance YTD, KRI is not all that cheap given the secular challenges and near-term cyclical issues faced by the industry. KRI is an attractive takeover candidate without a controlling shareholder and management has been shareholder friendly is terms of share repurchases. For those reasons, KRI is worth keeping an eye on as an alternative if the industry outlook improves.

Posted by Steve Birenberg at October 17, 2005 10:02 AM in KRI