Smiths News: a slowly melting ice cube
At the moment UK markets look very cheap, and a fertile hunting ground for new ideas. While looking through UK market screeners I stumbled across Smiths News ($SNWS), the UK’s largest newspaper distributor. Smiths is an interesting case of a high quality company in a declining industry, and I think looks very attractive at the right valuation. While it certainly is a melting ice cube, I believe the ice cube is melting slower than the market is predicting.
Smiths handles the entire chain of newspaper and magazine distribution. At 55% of the market, Smiths is the largest within the industry in the UK and is actually growing market share as its competitors go out of business or just lose contracts as papers become more price conscious. Like most industries there are significant economies of scale that allow Smiths to have lower costs and therefore prices than their competitors. The company is very profitable with very low fixed costs and a high (80%) ROIC.
The company is quite optically cheap, currently priced at around 4.5x normalised, trailing earnings. At a £117 market cap the company paid out £10m in dividends with a small £1.7m buyback representing a yield of 10%. The rest of their cash flow has gone towards paying down debt, which is attractive at 9% interest rates. As their debt decreases they will obviously be able to return more capital to shareholders. While they have reinvested in the business and acquisitions this has been fairly limited so far. Acquisitions are mainly made up of small, simple tuck in acquisitions that synergise with the core business at a reasonable price. Meanwhile, their growth initiatives mostly revolve around utilising their current network and facilities so don’t require a lot of extra capital.
The core question with Smiths is how quickly is the ice cube melting. Assuming a 10% IRR, the market is essentially pricing in 10% perpetual declines in earnings. Meanwhile, management has stated that they believe revenue declines will be 3-5% in the medium term. While volumes have been declining at around 10%, this will likely be somewhat offset by market share gains, cover price increases and most importantly growth initiatives. Smiths has been starting to experiment with leveraging their facilities and expertise in ways related to other similar products. This has been most successful in their recycling business which at essentially no extra cost has managed to contribute $1m of annualised profit so far. Additionally, Smiths has a fantastic track record of cutting costs with operating income remaining fairly stable in spite of a 28% decrease in revenues over the past decade. If they are able to continue to reduce operating costs at a faster rate than revenue declines then the business looks very attractive at current prices. For example, if the business can limit terminal decline to just 5% (which seems reasonable), the stock would yield a 15% irr.
A few important things to finish with. I like management, they seem to have a pragmatic approach to capital management. I always worry about acquisitions and reinvestments into a dying business in a situation like this but they seem committed to returning capital to shareholders and only investing when the return looks attractive. The management team and board almost all own stock in the company, though not a huge amount. The paying down of debt is attractive as it both derisks the company and provides a 9% return on capital. Additionally, downside seems limited considering I expect for around half the share price to be returned in dividends in just the next 3 years. While I don’t think this is the kind of investment that will be a crazy multibagger, I do believe that it will likely provide an attractive, low downside return over the next few years as the market realises how resilient the business is. At the time of writing I have a small position, but would be very interested in adding on weakness.