Fat Prophets Hot Stock - Fairfax Media (FXJ)

Monday 21st November 2016

What’s new?

Ugly ducklings are generally not ugly forever, and the same is usually true in the stock market. Times, companies, conditions, strategies, and management all change, and often this can see a stock move from being out-of favour to in-favour.

We attempt to pick such a metamorphosis ahead of time, and have had success in recent years, adding the likes of Nufarm, Coca-Cola Amatil, and Qantas (the latter being a standout success) back into the portfolio after an absence.

Sometimes stocks are cheap for a reason though, and we have also cast our view on ‘landmine’ stocks to avoid. We have consistently voiced this about Woolworths as one example, with more pain to come in our view given the structural competitive headwinds in the sector.

We have also previously cited Fairfax Media as a stock to avoid, with the company facing significant challenges from the digitalisation of media, and some initial complacency resulting in management being slow to respond.

There is no doubt that traditional media continues to face significant pressures in the digital age, but we have observed that Fairfax has moved more with the times in recent years, with management looking to turn competitive threats into an opportunity, and setting about a turnaround plan. We believe that significant progress has been made here, as highlighted at the company’s AGM earlier this month.

Outlook

Under Greg Hywood’s leadership Fairfax is turning around in our view, and perhaps a great deal more than the market is willing to give the company credit for. Not only has Australia’s oldest media company rationalised extensively and changed the orientation of its business model, but it has successfully challenged the more dominant Realestate.com.au in the major markets of Sydney and Melbourne (which account for around 40% of the real estate listing market).

Fairfax has repositioned across seven business groups, and has made a significant tilt towards digital in recent years. The company has a monthly digital audience of more than 11 million and 2 million in Australian and New Zealand, respectively. The radio unit Macquarie Media (culminated from the March 2015 merger of Fairfax Radio and Macquarie Radio) also reaches a national audience of around 2 million. The company’s 50 percent owned subscription video on demand service Stan has more than 600,000 active subscribers as at October.

What is also interesting is that Domain now claims around 40% market share of the key Sydney/Melbourne markets. We think the business will continue to make headway with a combined print/editorial digital strategy that differentiates it from the competition.

The split is a significant and very good move and will highlight the value being added in Domain which has been a stellar performer. Fairfax is valued on a marked discount to digitally oriented companies such as Carsales.com.au and Realestate.com.au, while the print assets are being ascribed little value by the market.

Price

Shares in Fairfax are trading at 13 times FY17 earnings and supported by what we regard as a reasonable technical overlay. In terms of the latter, we note that near-term overhead resistance is evident at $0.81 being the 200-week moving average, with a decisive break above this level likely to bolster broader term upward momentum. Should this occur, then an initial drive towards the 50-week moving average of $0.89 is feasible, with a band of long-term resistance situated between $1.07.

Worth buying?

For years the former media juggernaut has underperformed, but we think that phase is drawing to an end. Fairfax’s star asset, Domain, continues to be the growth engine and provide a serious challenge to the market leader realestate.com.au.

The market meanwhile is pricing Fairfax’s print media assets at close to zero anyway on a sum of parts basis. Fairfax is valued on a 12 times EV/EBITDA basis versus around 20 times for the likes of Carsales.com.au and realestate.com.au (REA). The print assets are ascribed little value by the market but the rot will not last forever, and there are signs that the industry is at last stabilising.

It is worth considering Domain’s competitor REA commands a market cap of $6.8 billion, whereas Fairfax as a whole sells for only $1.78 billion. With Domain on an equivalent basis worth in the vicinity of $1.5-$2 billion, the other media and print assets virtually come for free. Thus, while not without its risks, if anything Fairfax is now positioned for “upside” surprise catalysts and the valuation from our perspective has become quite compelling.

Greg Smith is Head of Research at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE

Disclosure: Fairfax is held within the Fat Prophets Concentrated Australian and Small/Midcap Portfolios.

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