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By Jeremy Glaser | 02-09-2011 01:52 PM

A Closer Read on Newspaper Bonds

Morningstar credit analyst Jocelyn Mackay sees some disconnect in the trading of New York Times and Gannett bonds.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

The newspaper industry was one of the hardest hit during the recession, and although companies like Gannett and The New York Times have come back from the brink, there are still questions about their long-term profitability.

To see what the current trends look like for bondholders of these companies, I'm here with Jocelyn MacKay. She is a credit analyst with Morningstar.

Jocelyn, thanks for joining me today.

Jocelyn Mackay: Thanks for having me.

Glaser: Let's start by just talking about how the recovery has treated the newspaper industry. Have they seen a big recovery in advertising sales? Have they seen sales of actual subscriptions go up? Or have things continued to be pretty dire?

MacKay: The newspaper industry still continues to post negative growth. We've seen an overall ad media spending increase for most of 2010 and continuing through 2011, but the newspaper industry is still seeing year-over-year declines in their print media business.

Glaser: Have any parts of the businesses been doing a little bit better?

MacKay: Their digital segments, and in Gannett's case their broadcasting segment, have rebounded because advertisers are willing to advertise both online and on television. They're just really shying away from that print business. But that being said, about three quarters of both Gannett and New York Times revenue is still tied to print media.

Glaser: At the height of the recession, it looked like the newspaper industry might not even be able to survive. Have we pulled away from that brink a little bit? Have advertising sales come back enough that the newspaper business is truly sustainable now?

MacKay: I think these both companies are very open to needing to go to different forms of media. They're still holding on to those newspapers, which are not likely to ever completely disappear, but they do recognize that they need to branch out into other forms of media to mitigate that revenue decline.

Glaser: So when you think about your credit ratings, have you made any changes recently? Have you thought about making any changes with respect to the fact that things are maybe a little bit less dire than they were before?

MacKay: Both companies have really done a lot toward improving their balance sheets, but we really don't think at this time a credit change is necessary. We rate them both below investment grade. We rated Gannett slightly higher at BB and New York Times BB minus.

We still think the industry is a declining business, but they generate great free cash flow. They don't need a lot of capex because when you're not printing a lot of newspapers, you don't need to spend a lot of money to keep those machines in perfect condition.

Glaser: Now, let's talk a little bit about the credit metrics of both Gannett and New York Times. Can you talk to us about what their debt levels look like, and if their cash flow cushion, and their other cash flow would be able to cover some of the debt they have out there now?

MacKay: Sure. Right now both of them have leveraged somewhere around the mid two times range, which really isn't terrible even for a cyclical company, but our fear is that if EBITDA does continue to decline and they're not able to pay down that debt, leverage levels could tick up. But we do forecast because of low capital expenditures, we do forecast that the companies will be able to pay off there near-term debt obligations.

Glaser: That sounds like the businesses are still producing enough cash flow right now to cover the debt, but we're a little bit concerned that another downturn could really make that very difficult for them.

MacKay: That's correct.

Glaser: Now when we look at individual bond issues, do you think they look attractive to investors on their own or is there a way that people could have some sort of pair trade with them together?

MacKay: I think there is a very interesting pair trade between New York Times and Gannett. We do rate, as I said, Gannett slightly higher at BB, and I think with the larger size much stronger margins, Gannett is a much better credit. Their bonds actually trade wider than New York Times bonds, and we'd actually expect that relationship to be flipped. They've got a maturity of about the same year--Gannett has a 20/15. New York Times has a 20/14, and those 20/14s really trade even tighter than the BB index. So that's surprising to me. I would expect New York Times bonds to widen out and Gannett's bonds to tighten in a little bit.

Glaser: So that could be an opportunity for investors there.

MacKay: Yep.

Glaser: Jocelyn, thanks so much for talking with me today.

MacKay: Thanks for having me.

Glaser: For Morningstar, I am Jeremy Glaser.

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