When I go into a clothing store, I always head immediately to the on-sale section. There's just no way I'm going to pay $75 for a dress shirt -- unless there's a $50 bill in the front pocket.
I feel the same way about the current stock market, where seemingly every stock is trading near all-time highs. Luckily, I was able to scrounge up a few interesting names in the bargain section of the stock market -- the 52-week-low lists. Here's one I think is worth a look.
Digging in the bargain bin
The stock market hated it when McClatchy (NYSE:MNI) doubled down on the old-media newspaper industry by buying Knight Ridder, a company twice McClatchy's size, last year. They hate it even more now that the bet hasn't worked out as well as the company had hoped, thanks to a weak advertising market, declining circulation numbers, and readers' continuing migration to the Internet.
However, following the Knight Ridder acquisition, McClatchy managed to offload 12 of the 32 newspapers it acquired, followed by the Star Tribune.
I'm not a very smart guy, so I like to forecast very predictable things, like guessing the Spurs will win the 2007 NBA championship. I also think there's a pretty decent chance that McClatchy's stock is undervalued, because of an easily predictable debt-paydown schedule -- which should provide a boost to free cash flow.
Down with debt!
In McClatchy's case, I notice that the company is heavily fixated on paying down debt. In the latest quarter, McClatchy had $2.75 billion in debt. It also had $230 million in land and assets for sale and a $200 million income tax refund, expected to be received next year. Combined, these should provide $370 million in after-tax proceeds.
I also calculate, based on a previous sale, that McClatchy's stake in CareerBuilder could easily be sold to joint venture partners Tribune (NYSE:TRB) or Gannett (NYSE:GCI) for about $250 million, which I'll roughly estimate as $200 million after tax. (Microsoft (NASDAQ:MSFT) also holds a minority stake in CareerBuilder.)
Lastly, I think the company can pay down $100 million in debt out of free cash flow over the course of the year. In total, I'm estimating that the company can pay down approximately $670 million of debt over the next year. At a recent analyst forum, McClatchy CEO Gary Pruitt targeted $600 million to $700 million in debt reduction over the next 18 months -- which I don't believe includes selling the CareerBuilder stake. So I believe my figures are very reasonable.
Up with free cash flow!
Using my numbers, I then calculate a free cash flow number. For my purposes, the definition of free cash flow is:
- EBITDA, minus ...
- Cash tax, minus ...
- Interest payments, minus ...
- Maintenance capital expenditures, without working-capital adjustments, because they don't seem material to a newspaper company.
My key assumptions are that revenue, extrapolating year-to-date numbers, falls about 5%, and that year-to-date EBITDA margins stay constant. Then, based on the new debt number, I subtract estimated cash taxes, maintenance capital expenditures, and interest expense.
After all of that, I believe McClatchy could generate in roughly $225 million in free cash flow during the year. (Keep in mind that there are moving pieces regarding when asset sales will be completed and debt paid down.) I also assume no improvement in margins, and a continuing decline in revenues.
Based on my estimates, McClatchy would be trading at a forward 10%-11% free cash flow yield, or more than twice what you could get on a Treasury bond. Anytime I can estimate a 10%-11% free cash flow without making overly aggressive assumptions, I get interested.
Optional upside
Part of McClatchy's current struggles stem from weak automotive and real estate advertising. It's reasonable to assume that at some point, the housing and auto markets will rebound, so I wouldn't extend the steep decline in ad revenue indefinitely.
If McClatchy is able to capitalize further on synergies and improve margins, or if it can stem advertising revenue decline, investors could enjoy be further upside. As a result, McClatchy shares might be a bargain at the going price.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
