Shares digital

It may have been written off, but the publisher’s recent rally has further to go

by Timon Day

Yell Group (YELL) 92p, Stop loss 74p

Shares summary

Yell will not go bust and the sell-off has been overdone. Profits should prove resilient, maintaining cashflow and allowing debt to be repaid.

Business:

Publisher of Yellow Pages and other classified advertising directories

Vital stats:

Market value: £719 million

Historic PE end March 2008: 3.5

Prospective PE March 2009: 2.4

Prospective PE March 2009: 2.5

Sector PE: 12.0

1-month relative strength: +54%

1-year relative strength: -75%

Yield 2008/9: 7.6%

NMS: 10,000

Spread: 0.3%

Over-borrowed and over here is a common refrain of disdain but it has reaped a rich harvest for short sellers. Such is the fear companies like Yell – with big debt and little growth – could end up going bust that their shares have been shunned like the plague.

Early July’s panic selling saw such stocks become oversold and they have subsequently rallied. Investors now have to decide whether the rebound has further to run before ‘fair’ value is achieved. Shares in Yell, which peaked at 644p in early 2007, have already rallied by 67% from their year low off 55p, and look good for another 50% taking them to the 140p mark.

The catalyst for the recent run was better-than-expected first quarter results on 24 July. These showed revenue up almost 3% at constant exchange rates and adjusted earnings per share ahead by a third. Better still, cashflow jumped 34% to £161 million with conversion into actual cash up from 83% of profits to 100%.

Cashflow is key to Yell’s recovery. The firm labours under a £3.6 billion debt burden, which equates to 2.5 times shareholders funds and 4.9 times earnings before interest, taxes, depreciation and amortisation of goodwill (EBITDA). Net debt was 1.8 times shareholders funds until Yell spent ?3.3 billion buying Publicidad in Spain in 2006.

If cashflow improves and the market believes Yell will not only prove capable of servicing its debts but also continue to pay a very decent dividend then the share’s recovery should continue.

The problem for Yell is its banking covenants become tighter, falling from five times EBITDA to 4.8 in March 2009, to 4.4 in March 2010 and four the year after that. Hopefully negotiations will relax these criteria – the company undoubtedly owes too much money for the banks to pull the plug.

If the banks refuse to ease the covenants Yell is likely to cut spending on IT and marketing to boost profits by between £100 million and £150 million. Analysts are already expecting a second consecutive cut in the dividend payout and a final alternative would be to ask shareholders for more money.

Yell should be able to turn very strong market positions in the UK, US and Spain and parts of Latin America into good free cashflow. Its Yellow Pages are rated the best advertising directory and the move to place the information online so people can access it through PC or mobile phone is gathering pace.

Internet listing revenue rose 40% to account for 16% of sales in June and is expected to be around 20% this time next year. Even if there is a recession it is unlikely advertising revenue will decline significantly as shops, tradesmen and other businesses are expected to continue their directory listings. A restructuring programme should also cut out £100 million of costs.

A prospective price/earnings ratio of 2.4 and a 7.6% yield – despite an expected cut in the dividend to 8.4p from 12p a year ago – leave the stock looking cheap relative to similarly cash generative, low growth peers such as BT (BT.A) and Daily Mail & General Trust (DMGT).