CBA today:
After a month that included a profit warning, announcement of significant structural change, and machinations between its Board and shareholders, S+P has placed Fairfax Media’s outlook on negative from stable (with the BB+ rating affirmed).
Fairfax expects that its ‘Fairfax of the Future’ plan will result in cost savings of $235m, after one off costs of $248m spread over 4 years. The plan has ongoing earnings risk given the likelihood that advertisers will continue to reallocate spend away from print within their ad budgets. No surprise that S+P's change in outlook mainly comes down to execution risks associated with that cost reduction initiative. “Execution risks include the uncertainty as to whether costs can be reduced fast enough to offset revenue declines, the cultural change required within the business to effectively reposition the cost base, and the impacts of the process on the group's brand reputation and products. In addition, we are cognizant that the rate of structural decline may accelerate as the weak operating environment persists in the short term”.
However, S+P still views its non metro businesses as supportive of the overall business profile. “We consider the regional business to be significantly better positioned to withstand these structural pressures given a more compelling offer for advertisers and lower competitive pressures. Furthermore, the group's digital businesses, particularly its 51% owned Trade Me and Australian real estate classified business, retain a strong growth outlook”.
Despite its recent EBITDA guidance of about $500m falling short of agency and street expectations S+P notes that it “continues to make meaningful progress in reducing debt leverage. For fiscal 2012, we estimate fully adjusted debt to EBITDA to be about 2.6x, which is in line with our expectations for a 'significant' financial risk profile”.
S+P expects market conditions to remain weak over the next 6 12 months. Assuming cost reductions are on track, no substantial acceleration in declining metro related revenues, and sufficient free operating cash flow (after capex) the agency believes Fairfax will maintain a fully adjusted debt to EBITDA of about 2.5x or less, which is consistent with the 'BB+' rating.
Downgrade risk occurs if there is continuing structural challenges or weaker than expected financial metrics. “If: the profitability of the metro media business significantly deteriorates as a result of further structural revenue declines and ineffective cost reduction strategies; or The structural erosion of the group's wider print based revenue materially accelerates and is not offset by new and defensible revenue streams”. Likewise, fully adjusted debt to EBITDA sustained at about 3x or more due to a persistently weak operating performance, debt funded acquisitions, or a more shareholder friendly approach to capital management could trigger a downgrade. We are presently looking at credit risk and gearing levels in the media sector and expect to publish our metrics shortly.
S+P noted Fairfax borrows primarily on an unsecured basis and has sufficient headroom within its financial covenants (net debt/EBITDA less than 4x and EBITDA/net interest greater than 3.25x). “At Dec. 25, 2011, these ratios were 2x and 4.8x, respectively. We expect Fairfax to maintain adequate headroom within financial covenants under a range of conservative forecast assumptions”.
