By Lauren Rich Fine, CFA, Merril Lynch
We enter 2004 cautiously. After several years of results coming in weaker than originally anticipated, 2004 has the potential to be a better year, but we are reluctant to stretch. In truth, while we expect newspaper industry ad revenue growth of 4.5%, more than twice the 2% growth we estimate occurred in 2003, we suspect it will prove to be more of a transition year to a more solid 2005, when growth should exceed 6%.
The economy is improving, help wanted ads are finally growing again, and most newspaper companies are investing in new products. While earnings prospects are fairly muted, there should be plenty of action ranging from M&A activity to more readership initiatives, and likely a healthy dose of analysis on whether help wanted behaves as expected given the new competitive landscape.
Last year started on a strong note, building off the momentum that began in the fourth quarter of 2002 when we estimate that industry ad revenues rose 4.5%. However, the war created an advertising malaise that never really lifted until late in the year. Real estate and auto classified remained strong during most of 2003, up 8.3% and 1.9%, respectively, through the first nine months of the year according to the NAA, although the latter started to decline in many markets late in the year.
Through the first nine months of 2003, help wanted ad revenues declined 12% but ticked upward for many newspapers later in the year, albeit not consistently. National was healthy in 2003, especially the telecommunications/wireless category. While the travel category deteriorated due to the war, for many newspapers this category helped second half growth.
Retail, which represents about 47% to 48% of total newspaper industry ad revenues, was a story of positives and negatives. NAA figures indicate that retail ad revenues were up 1.6% during the first nine months of 2003. Preprinted inserts were incredibly strong throughout 2003, up at a high single to low double-digit pace for many companies.
Department store advertising, or the lack there of, put pressure on results beginning late in the second quarter as Dillard’s and Federated changed their marketing strategies. This still large category dampened some of the momentum that had been expected in the second half of 2003.
Internet ad revenues were particularly robust during 2003, especially within the classified sector. Many companies now present category ad revenues combining print and Internet, especially as it is typically an upsell or a joint sales process.
We recently raised our 2004 ad revenue forecast for newspapers to 4.5% from 4%; specifically, we expect classified to perform a bit better as the mix changes more favorably towards the higher rated help wanted ad revenue stream.
ML Economics is forecasting real GDP growth of 4%, which we estimate will produce 5% classified ad volume growth; we assume the mix shift will produce an effective 3% rate increase for the category. Help wanted should lead the way among classified categories, while we believe that auto will decline and real estate will soften.
Retail advertising is likely to remain muted as department stores remain under secular pressure, although comparisons will ease as the industry cycles against year ago results depressed by the Iraqi War and the initial pullback from the department stores.
Preprints will likely continue to grow at a mid single digit rate, if not better. This highly competitive category is being embraced by the industry as a profitable growth category; companies have been investing in their insertion equipment. We also have heard several companies indicate that they will focus on local single sheet inserts that can piggyback off of the national retail inserts and/or work in conjunction with direct mail campaigns.
National advertising should be decent. Notwithstanding cellular phone number portability, we find it hard to believe that the telecom category will rise significantly as the category was so strong in 2003, but we certainly expect the spending to hold.
We expect more new product launches in 2004 aimed at improving and broadening readership. At a recent media conference, several companies indicated that they expect incremental top line growth related to these new products and, therefore (of course), incremental costs. We think this adds an element of excitement and risk to the newspaper stocks.
On one hand, incremental revenue growth would be greeted enthusiastically by Wall Street, on the other, investors are looking for cyclical operating leverage and might feel let down if earnings growth is hampered by these investments, which are unlikely to have immediate positive returns. Moreover, while public companies will likely try to time their investments to coincide with the revenue gains, their ability to get this right adds an element of risk in meeting earnings expectations.
We suspect that the FCC will continue to review the media ownership rules and believe that cross ownership will be permitted, particularly in larger cities. Once the rules are clarified, we believe there should be a robust level of M&A activity as several companies have indicated that they have been involved in numerous conversations, but that sellers have been reluctant given the lack of clarity regarding the rules.
Newspaper/TV combinations and duopolies are likely to be the most prevalent transactions. We do not expect a lot of full company takeouts so much as a series of swaps to gain market cluster efficiencies.
So, after several years of tame controllable cost increases, offset by higher retirement costs, pension costs, and healthcare costs, we expect cost pressures in 2004 to come from a different direction. Newspapers will invest in their product and it will cost real money. Newsprint costs will also come under pressure as the newsprint manufacturers continue to shutdown capacity to reduce supply enough to permit price increases in the face of somewhat higher demand.