McClatchy, Like Gannett, Reported Better Q2 Results Than Expected But Hold The Champagne, It Has All Been Achieved On The Cost Side And Revenue Is Still Down 30%

Philip M. Stone July 22, 2009 Follow on Twitter

You don’t often see a company reporting 30% revenue declines for each month in a quarter and yet see its share price go up near 50% on the day, but that’s what McClatchy achieved Tuesday.

The doubling of its Q2 earnings to 50 cents a share from the same quarter a year ago surprised analysts just as they were surprised by Gannett’s better figures reported last week, but the reason  for both companies doing better is the same – the vicious cost-cutting  has reached the level where decent margins are being  restored.  For now, at least, fewer but enough print readers are sticking around for their much thinner produced daily read, and McClatchy could boast that each of its 30 daily newspapers is providing positive cash flow, with overall cash flow margin of 25.3% compared to 21.2% a year ago.

As for the shares, the “shorts” had bid them down so low, at 54 cents, that even the slightest good news meant they would need to cover, so it was buy at any price. That’s why at one point Tuesday McClatchy shares actually rose 60% in value before falling back to close up 48.15% on the day. That’s a huge percentage daily rise, and there was a further 7.5% increase after hours. But all things are relative -- the shares still remain less than $1 each – the official close was 0.80 cents.

But almost all of that positive news came from the cost-cutting side, not the revenue side. Cash expenses were down 29.3% in the quarter, but that figure does not include significant severance charges for the 1,600 employees laid off this year – some 15% of its workforce.

Buried among the revenue figures was a little good news -- that circulation revenue for the first six months of the year rose by nearly $4 million – some 2.9% -- which goes to show that even though circulation itself dropped by around 12%, there were enough people out there willing to pay more for less, and for the company that means less circulation but at higher rates was a successful ploy when added to strategy of cutting off outlying distribution areas. The company believes its actual readership decline in percentage terms is much smaller than its circulation decline, and it is readership that it is promoting to advertisers these days, not circulation.

But no matter how you look at it there is still a load of sorrow on the revenue side.  April advertising revenue was down 31.1% compared to Q2 last year, May declined 30.7%, June was down 28.3% and July’s performance is said to be similar to June.  Those looking for any positive will note the advertising drop is bottoming out, that May was a bit better than April and June a bit better than May, but in reality at these levels it’s all very sour.

Even online ad revenue dropped in the quarter, by 2.9%, primarily because of a huge drop-off in employment ads. The company boasts that Q2 digital advertising represented 16.5% of total advertising, up from 11.8% from the year before, but is that really something to boast about or is it more a clue to how severely print advertising revenue has dropped? It’s probably a lot of print loss coupled with some digital gain.

But McClatchy is ahead of most in trying to transform itself from solely a print newspaper business to a print, online and handheld devices business. It is getting the visitor growth it needs for its digital products – website visitors were up 30% in the quarter -- but how to make money with advertising down?

With its cash flow, circulation revenue up, earnings per share doubled, one might think that bliss has returned to the country’s third largest newspaper-digital-handheld company but we haven’t yet mentioned the elephant in the room – that outstanding $2 billion of debt, most of it emanating from its Knight-Ridder purchase.

So, is existing cash flow sufficient to handle debt payments assuming there is little improvement on the revenue side for the rest of this year and into next? Is the cash flow sufficient to handle the various revenue to debt covenants in the loans?

CEO Gary Pruitt says the plan for the rest of the year is to “remain vigilant in our efforts to become more efficient and permanently reduce costs.” For an employee that means keep the head low for some time to come.

And Chief Financial Officer Pat Talamantes noted the ratio of revenue to debt was now around 5.8 times, well within the recently renegotiated level of 7.0 times (but dangerously close to the 6.0 before it got renegotiated) and the interest coverage ratio is around 2.8, well more than the 2.0 called for, so with no debt maturing until 2011 the company sounds confident it will meet its obligations.

That’s probably why Pruitt took the occasion to lambast  analysts who have been chirping away for some time that the end is near, such as Fitch Ratings’ Michael Simonton  who said a few days ago that McClatchy’s “default is imminent or inevitable.” Pruitt noted, “There has been a steady drumbeat is recent media and analyst reports about the prospects of McClatchy violating bank covenants this year. We think it is important to note that even if our advertising performance does not improve from its current run rate for the rest of the year, we would not breach our bank covenants. In the meantime, we will continue to reduce our debt.”

The bottom line appears to be the situation has stabilized but the cost cutting is by no means done, nor is selling property and the like to bring in additional revenue, for the top priority is to pay down that debt that comes due in 2011. But at least the company has reached the stage where it has downsized itself appropriately to its revenue stream, decent cash flow is being produced, and when advertising returns so much the better.

In this day and age that, at least, is an achievement.