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January 26, 2006

Dow Jones Showing Some Potential

I have no real complaints with the earnings report or conference call from Dow Jones (DJ). The report and guidance commentary is inline with evidence of upside potential to the 2006 outlook. This optimism has the stock trading higher, up 2% when the call started and up 3% as the call wraps up.

I can’t really get comfortable with valuation at DJ when it trades at a 20% plus premium to the group even if you assume operating leverage in 2006 and 2007. However, I also understand the willingness of investors to pay a premium and follow improved momentum in operating fundamentals. Given the good action in the shares of late as long as optimism about upside to 2006 and 2007 results holds, I think the shares could trade to the low to mid-$40s. I won’t be aboard for that trade though as my approach in media tends to look for value and growth, not growth and momentum....

DJ reported 41 cents in the quarter against a 40 cents consensus estimate. Revenues of $482 million matched consensus. At the segment level, Print Publishing operating results looked light to me, while Electronic Publishing looked better than expected. Print revenues were OK but margins seem light. Management noted several items that pressured costs such as newsprint, severance, circulation and promotion initiatives, and Weekend Edition. Excluding these areas, expense control was fine. Management feels these areas will moderate considerably as 2006 unfolds.

Electronic Publishing results were driven by better than expected margins with operating profits coming in better than expected and offsetting the shortfall in margins in Print Publishing. There was one issue in Electronic Publishing which seemed to bother analysts based on numerous questions: Consumer Electronic Publishing, composed of Marketwatch and WSJ.com, had only 11% growth in the fourth quarter. Given growth rates in other internet media advertising this is clearly too low. Management admitted this and pointed to transition issues at Marketwatch related to changes in advertising sales executives, consolidation of online brokerage firms, and new selling strategies. Management seemed confident that these issues were behind the company ad revenue growth would accelerate in 2006. This area represented 10% of DJ's fourth quarter revenue, the highest online exposure of any newspaper company. IF you want to argue for a premium valuation for DJ, this is the reason why. Not just the fact that the relative exposure is higher but also that potential upside for these national brands is higher than other newspapers may have with locally based websites.

Regarding 2006 guidance, 1Q06 EPS was projected at "low teens" with advertising linage growth in the mid single digits. Weekend Edition dilution of 6 cents is a penny or tow higher than expected. Overall, I'd call this guidance in line with current expectations. New CEO Rich Zannino provided a good amount of color on the full year 2006 and I'd say he was optimistic and this accounts for the good reaction in the shares. Basically, he outlined a year that would show strong underlying momentum in revenues with margin expansion. Better trends at the Journal will be accompanied by a pickup in revenue growth at Electronic Publishing. Given the higher than expected margin base in Electronic Publishing in the fourth quarter this provides upside to current EPS estimates.

As stated in the beginning, I understand the reason for the optimism and could bless jumping in on DJ at current prices if I were a more momentum based investor in media stocks. For now, investors are going to give DJ the benefit of the doubt and assume operating momentum will accelerate. At the first sign that this maybe a falsse start, the shares will get ugly, but until that point – which may not occur – downside risk is not significant for DJ shares.

Posted by Steve Birenberg at January 26, 2006 03:46 PM in DJ