Printing Returns for Bondholders

Jeremy Glaser: Will publishing giant RR Donnelley's bonds be printing returns for fixed income investors? I'm Jeremy Glaser with Morningstar.com. I'm here today with Joscelyn MacKay to take a deeper dive. Joscelyn, thanks for joining me.

Joscelyn MacKay: Thanks for having me.

Glaser: So starting with kind of the bird's eye view of the publishing industry, how hard was it hit by the economic downturn?

MacKay: The publishing industry is highly cyclical and like every other cyclical industry, it was hard hit during the downturn. Capacity utilization in the industry steeply declined, and the excess capacity from this lower volume actually intensified the price competition.

Glaser: So if companies were sending out less pieces of direct mail or you need to print less promotional materials, this is going to hit companies like RR Donnelley pretty hard?

MacKay: Exactly.

Glaser: So what did that do to some of the credit metrics that you look at? Presumably it did not help the bottom line.

MacKay: No. Despite paying down over $800 million in debt last year, the company's credit profile definitely deteriorated. The EBITDA declined, which led to a steep increase in leverage. Leverage at the end of the year was 3.1 times versus 2.4 times the year prior.

Glaser: So credit metrics were declining and earnings weren't doing very well, but recently we came out with the credit rating for RR Donnelley and said that it was investment grade and the lowest investment grade rating. What could led to that conclusion?

MacKay: We do expect RR Donnelley's leverage to return to historical levels. Management has a 2 and a 2.5 times target, which we think is very attainable and very appropriate for such a cyclical industry. Management has also been very focused on cash flow. During the downturn, they offered to reduce the dividend if they needed to, if they have really needed to improve cash flow to pay down debt, but we're happy that they actually didn't have to do that. Lastly, RR Donnelley is the market share leader in this industry and they have the broadest product and service offering.

Glaser: So it seems like they will be able to ride the recovery when it comes and they will be able to take advantage of that. What are some of the things that could happen on the downside that could put investors at risk?

MacKay: RR Donnelley has been highly acquisitive in the past and so I'd say the prime risk for credit investor would be that the company levers up its balance sheet for some large acquisitions.

Glaser: So looking at the bonds that are traded in the market today, do they trade like investment rated company?

MacKay: They don't. RR Donnelley's bonds trade much wider than, I'd say, a weak investment grade credit. So we think that there's just got to be some room to tighten there. I think the market is probably weighing on the company's poor results that they just kept on posting during the downturn.

Glaser: Are there any particular bond issues that you think look particularly attractive?

MacKay: We probably focus on the ones that are in the 10-year range. It's probably hard to discuss some of the trading levels of the more near-dated maturities, but the ones that are around 10 years are trading at spreads north of 400 basis points, which we think should be much tighter.

Glaser: Joscelyn, thanks for talking with me today.

MacKay: Thanks for having me.

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