Reading between the lines
The media sector has seen heavy selling pressure since last Friday, when Fairfax Media (ASX:FXJ), Nine Entertainment, and Domain Holdings Australia all released trading updates, with these coming ahead of the formal commencement of the merger process between Fairfax and Nine. The statements were all very brief, but signs of further softness in the advertising market were not treated lightly by investors. All three stocks were down around 13% on the day. The reaction (and further weakness since) was overly harsh in our view, but typical of what a market does when under pressure.
Fairfax (ASX:FXJ) indicated that FY19 year to date group revenues are 5% below last year. On a segment basis, turnover at Metro Media is down around 1%, while publishing is flat. The top line at Australian Community Media is down around 10%, while the New Zealand division has seen revenues retreat by around 15% in constant currency terms. On the plus side, the Macquarie venture has seen revenues rise 4% on a continuing basis, while digital revenues at Domain are 6% higher.
Domain for its part reported that total revenues for the first 15 weeks of FY19 were 1% lower year-on-year, despite the ongoing growth in digital, with this due to a lower level of listings and auction volumes in Sydney and Melbourne. Domain also reported an increase in costs, with pro forma total costs 7% higher, and underlying costs up 1% year to date. The company is expecting these to increase for the full year by mid-to-high, and low single-digits respectively. Additional cost savings initiatives are however being pursued.
Nine Entertainment updated that the advertising market has been softer than expected, but that the company has achieved market share gains.
Metro FTA advertising is relatively flat in Q1 FY18. Again, Nine highlighted progress in digital, with revenues ahead 10% for the September quarter. The company still expects FY19 earnings in the range of $280-$300 million.
The softness in the advertising market evident in the trading updates rattled investors, but excessively so in our view, on a number of counts.
Firstly, the challenges being faced by traditional media advertising channels are nothing new, and indeed are a key premise of the merger between Fairfax and Nine. The combination will in our view strengthen the enlarged entity as it looks to combat industry disruption. Significant synergies will be extracted from the merger, and this along with further cost cutting, will boost earnings. Growth in higher margin digital channel revenues (a common feature of the three trading updates) will also drive profitability.
Secondly, for Domain, softness in key property markets has clearly taken some toll, with the level of digital revenue growth softening but still quite robust. The property market in cities such as Sydney and Melbourne have weakened, and this was confirmed by data from the ABS on Friday which showed that the total value of total housing finance fell 2.1% to $30.667 billion in August. However, activity should pick up as vendors reset their expectations, and as it dawns that peak property market levels will not be seen for a very long time.
Costs are clearly in focus for Domain but we continue to believe that having a majority shareholder with even more scale is a clear positive for the company.
Management at Nine have made it clear that Domain was a key driver of the deal, and they will also get to work on extracting cost and revenue synergies. And it probably won’t be long before Nine makes a bid for total control.
Domain has also been caught up in the tech unwind as well, but we continue to believe that the growth prospects at the company are strong, and deserved of a high earnings multiple (30 times for next year) given the operating leverage present.
Turning to the chart of Domain, the adverse trading updates have damaged the short term technical picture, and seen multiple layers of support take out. The next buttress at the 138.2% Fibonacci retracement at $2.56 is now in focus and needs to hold. Some time will now be needed to repair the technical damage.
Nine shares have weakened and this has eroded the premium that had been available to Fairfax shareholders following the scrip-based merger. We think the combination still has merit however, and with significant synergies set to be extracted. Fairfax’s earnings multiple of around 13 times remains modest, although there would be further slippage if the merger were not to proceed.
Turning to the charts, the adverse trading updates have damaged the short term technical picture Fairfax Media (ASX:FXJ). Prices have dropped below dynamic support at the 200-day (green line) and 50 day (red line) moving averages. In-turn, the upward sloping green dotted trend-line has been breached. Some time will now be needed to repair the technical damage.
On the monthly chart, resistance was respected at the 61.8% Fibonacci retracement of $0.92 as represented by the red set of retracements in November 2017, and this is likely to remain formidable near-term. This led to a short-term correction to evolve, but structural support has formed at the 38.2% Fibonacci retracement around $0.67. Prices are testing this level currently, and a holding pattern around here would be positive. The upward sloping trend line remains intact at this stage.
We recommend Members maintain their holdings in Fairfax Media (ASX:FXJ). We continue to rate Domain as a buy for Members without exposure and with a medium to long term horizon.
Disclosure: Fairfax Media (ASX:FXJ) and Domain Holdings Australia are held in the Fat Prophets Global Contrarian Fund (ASX: FPC). Both companies are also held in the Fat Prophets Concentrated Australian and Small/Mid-cap managed account portfolios.
