Loss-making Smiths News owner Connect Group (LSE:CNCT) could be the next major UK business to flop.
2017 was the last time the group was in profit. Dividends of 9.8p per share that year are a distant memory. At last count dividends per share were at 1p. These two years of underperformance now see net debt at £73.9 million, with a debt to capital ratio of over 400%.
It is clear the market has priced in this weakness and do not trust Connect to deliver. A trailing P/E ratio of under four times earnings bears this out.
The shares have recovered a little from a 28% plunge between early October and early December of last year, but the main concern for the long-term outlook is based on structural weakness outside of Connect Group’s control.
However, as well-run the business itself might be, the fact is that the sector it operates in has a dim future. In the last five years, Connect’s shareholders have seen the value of their shares crater by 80%.
Unless you have been living under a rock for the past ten years, you will know that legacy media and those that sell these products are a sector in serious decline.
The fact is that newspaper groups are, in the main, contracting and not expanding. There are some notable exceptions, in the likes of Daily Mirror and Daily Express publisher Reach (LSE:RCH) — formerly Trinity Mirror — which has seen its share price boom 183% in the last 12 months, mainly through acquisitions and economies of scale.
However, broadly speaking, newspaper readership has been falling and local newspapers have been closing at record pace in the past decade and a half.
Newspapers are not the moneymaking powerhouses they once were. Ad spend has moved online, but the rise of the all-encompassing tech giants means that regional publishers’ budgets have been decimated. Companies large and small are now much more likely to buy SEO services to rank highly in Google or on Facebook than they are splash on expensive newspaper or magazine advertising.
Connect Group was operating in a totally different world when it was founded in 2006 from the demerger of the now-FTSE 250 listed WH Smiths (LSE:SMWH). That Swindon-headquartered newsagent, for all its issues, now represents a much better investment prospect than Connect.
Even with dividends included in the calculation, Connect’s shareholders are down nearly 10% in the last 12 months.
While Connect managed to cut its after-tax losses from minus £38.5 million in 2018 to minus £31.5 million in 2019, I do not see this as simple short-term weakness. I believe Connect, like the newspapers it sells wholesale, could be going the way of the dodo.
By 2021 the board is still hoping to reduce its net debt to EBITDA to a ratio of 1, funding this deleveraging from any surplus operational cash and any money it makes from its sell-off and lease-back of Tuffnells distribution depots.
Some good news
Chairman Gary Kennedy has suggested that Smiths News is on the road back to full strength. It certainly comprises Connect Group’s most profitable division and remains its best chance for success.
In July 2018, the newspaper distributor won a five-year, £200 million-a-year contract extension with Rupert Murdoch’s News UK, publisher of The Times and The Sun. That figure represented more than 10% of full year group revenue.
Following, in September 2019, was the news that Connect had won a £100 million a year distribution deal with The Telegraph, with former group chief executive Jos Opdeweegh noting that “since September 2018 we have successfully renewed over £900 million of annual revenues, underpinning the long-term sustainability of Smiths News and its contribution to the group as a whole.“
Its other main subsidiary Tuffnells, the bulk freight distributor, has been the cause of many of Connect’s woes.
In the group’s 2019 annual report Gary Kennedy said that while cost savings had offset some of the impact of declining sales:
“After an extremely challenging year, we are implementing a strategic review to determine the most appropriate structure and strategy for the Tuffnells business and, more widely, to consider its role and future in the Group.”
The Sheffield-headquartered parcel delivery service saw Jos Opdeweegh step down in November 2019, replaced by interim chief executive John Bunting.
Preliminary results for the year ending 31 August 2019 showed sales down 6.4% to £164.6 million, giving the distributor an operating loss of £14.1 million.
A plan to sell off all 37 Tuffnells depots had to be cut short last year when no buyers were found. Connect did at least manage to drum up £9.9 million by selling six locations to Urban Logistic REIT (LSE:SHED) with the proviso that they were immediately leased back. This was followed by two further disposals in November 2019 for £5.1m, again on a leaseback agreement.
Tuffnells has only been a part of Connect since December 2014, when the latter paid in the region of £130 million. Far from being a useful expansion, Tuffnells now appears to be another heavy weight that Connect cannot carry.
A series of pretty dismal updates and profit warnings has sunk sentiment and I would wager there is more downside to come.
That full-year revenue has fallen every year for the last five years: from £1.85 billion in 2015 to £1.47 billion in 2019, suggests that long-term growth is a major issue.
The shares tumbled 46% in one day on 13 June 2018 after Connect Group issued what it called an “extremely disappointing” trading update, warned on profits, cut its dividend by 80%, shuttered its click-and-collect service Pass My Parcel and “materially” downgraded its outlook for the year. In the same announcement, chief executive Mark Cashmore and chief financial officer David Bauernfeind both exited.
At the time, AJ Bell investment director Russ Mould called it an “embarrassing” situation. “Six years ago, it was faced with a core business in steady decline,” he wrote. “That prompted a move into new areas [like] parcel freight as the future of the business.”
With Tuffnells failing to pull its weight, that future looks darker than ever.