LONDON -- Some of my most successful investments over the years have come from backing companies in sectors that are out of favor with the market. Short-term doom and gloom about an industry can often provide great value opportunities for investors with long-term horizons.
Investing legend Warren Buffett -- the world's third-richest man -- believes he has found such an opportunity in the unloved U.K. retail sector. The Motley Fool special report "The One UK Share Warren Buffett Loves" gives you the full story on this one -- and you can download your copy right now for free.
Buffett has also been buying up newspapers (on his home U.S. turf), which is encouraging for me because, in the past month or so, I've become rather excited about the valuation of a particular U.K. company in this unfashionable sector.
Doom and gloom
A number of factors have weighed heavily on the share prices of U.K. newspaper groups in recent years:
- The industry is undergoing structural change as companies face the challenge of more and more people reading news online.
- U.K. groups went into the credit crunch and recession with too much debt on their balance sheets, and borrowings remain relatively high as cost-cutting has only offset the cyclical drop in advertising revenues.
- The News of the World phone-hacking scandal, which came to a head last year, raised fears of widespread illegal journalistic practices and their financial impact on newspaper publishers.
More doom and gloom
Against an overall negative industry backdrop, two further company-specific factors have recently weighed on the shares of Daily Mail & General Trust (LSE: DMGT.L ) .
The owner of the Daily Mail, Mail on Sunday, free newspaper Metro, and various regional titles has two classes of shares: nonvoting, of which there are 363 million, and voting, of which there are 20 million.
The nonvoting shares are trading at 385 pence, and the voting shares at 485 pence, giving the group a market capitalization of around 1.5 billion pounds. A top FTSE 250 index company? Yes -- until recently.
In April, the FTSE announced that, under new index rules, Daily Mail & General Trust's nonvoting shares would no longer be eligible for inclusion in the FTSE U.K. index series, and that the shares would leave the FTSE 250 and FTSE All-Share indexes on June 18. As such, index-tracker funds -- and any actively managed funds with a remit to invest only within either of the indexes -- have been obliged to sell all their DMGT shares.
At the same time, there has been additional downward pressure on the shares from a hefty sell by Daily Mail editor Paul Dacre, who also sits on the main board of directors. The sale of 100,205 shares netted Dacre more than 400,000 pounds and left him with just 37,861 shares in the company.
The price is right…now.
You might think that the fall in DMGT's shares from more than 13 pounds at their peak in 2000 to less than 4 pounds today is indicative of a company in terminal decline. But the business has actually grown over the period, and the annual dividend has risen from 8 pence to 17 pence per share.
What has happened is that DMGT's shares have gone from a super-high earnings rating at the exuberant turn of the millennium to a very modest one today. The current DMGT share price of 385 pence represents a price-to-earnings ratio of eight, based on forecasts for the year ending September 2012. And the forward dividend yield is a healthy 4.7%.
Beyond the short term
Ironically, Daily Mail & General Trust looks an infinitely healthier animal for the digital age than it was 10 years ago.
At the end of last year, MailOnline overtook the website of the New York Times to become the most popular newspaper-owned website in the world. The first quarter of this year saw an average of 94 million monthly unique visitors -- 63% higher than for the corresponding period to March 2011 -- and total revenues 75% higher than the prior half-year.
Moreover, at a recent investor day, the company suggested MailOnline should generate around 45 million pounds of online advertising revenues in fiscal 2013, with a target of 100 million pounds for 2018. Increasingly, most of the revenue from this source should drop straight to the bottom line as pure profit. Current annualized net profit for the entire Daily Mail & General Trust group is running at around 140 million pounds.
Other promising online developments include the merger of DMGT's popular FindaProperty.com and Primelocation.com websites with those of Zoopla. DMGT owns 55% of the merged entity, which will challenge the dominant player in the sector, Rightmove (LSE: RMV.L ) . Rightmove turned a 47 million pound profit in 2011.
At the same time, I expect DMGT's strong stable of business-to-business operations -- in areas as diverse as risk management, information, and events -- to continue to grow strongly. These assets include a 68% stake in Euromoney Institutional Investor an FTSE 250 firm that alone is valued at more than 900 million pounds by the market.
Foolish bottom line
Daily Mail & General Trust looks like a classic undervalued share in an out-of-favor sector to me, with the technical selling as a result of the FTSE's index rule changes only adding to the undervaluation.
When I wrote about the company a year ago, the DMGT shares were trading at 450 pence. I thought they looked cheap for the long term, with a reasonable dividend providing some recompense in the short term, but I said I might be inclined to wait for a better price, which would likely come in time.
That time has now come!
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