R.R. Donnelley & Sons (RRD) is an international printing company, with the majority of sales derived from printing magazines, books, catalogs, directories, retail inserts, financial documents, forms and labels. The company has also attempted to diversify and currently offers logistics services and some digital media services, but the bulk of its sales are still derived from print media. Since my first article on R.R. Donnelley, a rather negative piece, the stock has declined from a 9/11/12 close of $11.96 to a close on 2/22/13 of $9.83. Factor in the $0.52 in dividends, and the total return is a loss of (13.5%) in a little over five months.
I remain decidedly negative on the stock, and this article will put forth 8 possible things that could go wrong this week for the company, centered around the fourth quarter earnings release Tuesday before the market opens and 10 a.m. ET press conference. These items include poor earnings, poor sales, poor cash flows, "one time" charges, a reduction in the dividend, lowered guidance, analyst downgrades, and a credit downgrade. I will also throw in a few wild cards for additional consideration.
The Past Being Reported
The first item to worry about this week will be non-GAAP earnings. The company and analysts both use non-GAAP earnings as the standard measure for quarterly and yearly comparisons. These earnings leave out all the special "one time" charges, although with R.R. Donnelley, these charges have been anything but one time expenses. The following table shows the previous six quarters earnings and sales progression for the company:
|Quarter||Current EPS||Previous EPS||% change||sales %|
As one can see, company earnings have remained in a narrow range of $0.44-$0.53 per share for the last 12 quarters, with one exception. For this fourth quarter, both the company and analysts have guided below the general range, with the average analyst estimate (out of 5 analysts) at $0.37, while the company has guided at the low end of a range, which puts earnings around $0.42-$0.43 per share, on a non-GAAP basis. Although highly unlikely, what could go wrong here is a miss of the company's own earnings estimate, or even more unlikely, a miss of the analysts' estimate. In the past four quarters, the company has beat the analysts each time. If the company were to miss these estimates, the stock could take a big drop, though again, this is highly unlikely.
Referencing the above table, the company's sales have been in deceleration over the past several quarters. Both the company and analysts expect a decline in sales for Q4 similar to Q3. Again, missing the estimates is unlikely, but certainly possible. Missing the sales estimate would be worse for the company than missing the earnings estimate, as this would affect other worrisome items, such as the credit rating, as discussed later.
A lot of the valuation of R.R. Donnelley relies on the cash flow and its ability to pay dividends. By the company's own estimates in the 3rd quarter earnings release, operating cash flow is expected to be around $450 million before capital expenditures. This number is more important than sales and earnings, as the ability to pay dividends, the ability to pay down debts in the future, and the company's credit rating all rely heavily on a steady operating cash flow. With 182 million diluted shares outstanding and a dividend of $1.04 per share annually, the company will spend $189 million of its cash flow on dividends alone, assuming the dividend rate is held. Any short fall in cash flow is likely to hit the stock hard and become a worry for bond holders as well.
As shown in the 3rd quarter SEC filing, the company had a net drawdown in cash over the first nine months of 2012 of $56.8 million, as compared to $151 million in the first nine moths of 2011. The company had $392 million in cash at the end of the quarter. The amount of cash as compared to debt is alarming. In roughly the next five years, through May 15, 2018, the company has $2,028 million in debt due. With current cash of roughly $400 million, the company has to come up with $1.6 billion in cash to cover debt over the next five years, or convince investors to fork over additional financing. Therefore, of the things that could go wrong this week for R.R. Donnelley, missing on the cash flow number would set off a chain of negative events, and may be the most important number for the company to hit.
Every year, the company assesses the value of goodwill held on the books on October 31. If the value of the goodwill declines, this results in a charge for fourth quarter earnings. Last year, the company reported $507 million in restructuring and impairment charges for the fourth quarter and $667 million on the year. Between this and other factors, equity eroded by nearly $1.2 billion to just over $1 billion by the end of 2011.
Like most companies, management tries to steer investors towards focusing on a particular set of numbers. In this case, management highlights cash flow from operating activities, minus capital expenditures, the new businesses the company has acquired, and their changing product mix. However, all the acquisitions that created the goodwill have to be evaluated for their future potential. When the potential declines, charges result and equity erodes. As of the end of the third quarter, the company still had $2.27 billion in goodwill on the books, versus $1.15 billion in equity. This is the biggest reason I believe there is little to no value left in the company. Impairment charges are likely to occur once again in this fourth quarter report, and will likely erode equity once again. Charges are definitely something that could go wrong this week for R.R. Donnelley.
The Future Being Projected
R.R. Donnelley has been a stalwart when it comes to paying dividends. For this reason, many investors continue to hold shares over time and defend the company's prospects, despite losing more money on the share price decline than what is being paid out in dividends. As I highlighted in a past article, to have bought this company for the dividends and held long term would have been a losing prospect for the last decade. Simply put, the share price has declined faster than the company has been able to pay dividends. However, the current high yield of 10.6% has likely created somewhat of a floor on the company's price. If management were allude to a change in this policy in either the earnings press release or conference call, the stock would suffer immensely. A change in dividend policy is certainly one thing that could go wrong this week for R.R. Donnelley.
The company typically offers three items in its guidance for investor consideration. The first item is usually annual sales, which the analysts put at a moderate decline of 2.1% to $9.96 billion in 2013, according to Yahoo. The second item typically provided is non-GAAP earnings, which the analysts put at $1.70 for 2013, or a 5% decline from their 2012 estimates. The third item is cash flow, which is the most important item for bondholders, those expecting continued dividends, and the credit rating agencies.
All three of these items will be negatively impacted by the e-book and e-reader market. Amazon CEO Jeff Bezos, perhaps the authority on media sales, had this to say about the e-reader/e-book category versus print for the fourth quarter of 2012 in the company's earnings release:
"We're now seeing the transition we've been expecting," said Jeff Bezos, founder and CEO of Amazon.com. "After 5 years, eBooks is a multi-billion dollar category for us and growing fast -- up approximately 70% last year. In contrast, our physical book sales experienced the lowest December growth rate in our 17 years as a book seller, up just 5%. We're excited and very grateful to our customers for their response to Kindle and our ever expanding ecosystem and selection."
The largest share of R.R. Donnelley's business comes from print media. With a statement like this from Jeff Bezos, the reality of the decline of print media is becoming evident. Not only can one bypass a physical book with an e-reader, but other items such as magazines and phone books are heading to digital media and can be accessed by e-readers.
A growing part of R.R. Donnelley's business has been the logistics segment, namely its logistics services for the United States Postal Service. In recent weeks, the pending end to Saturday delivery for the USPS has been highly publicized, as this arena of printed media is also in decline.
Although R.R. Donnelley has made inroads into the digital media business, it's a small part of the company's overall sales and in 2013, I do not expect it to grow fast enough to counter the decline in print media. Therefore, I believe guidance to be one of the biggest things that could go wrong for the company this week.
With any earnings report, analysts are likely to come out and adjust guidance and their buy/sell/hold recommendations on a stock. If any of the aforementioned possibilities of things that could go wrong this week for R.R. Donnelley comes to fruition, it's likely an analyst downgrade or downward revision in earnings guidance will be seen.
The last of the 8 thing that could go wrong this week is a downgrade to the credit rating of R.R. Donnelley. A shortfall on sales, earnings, or cash flow could affect the company's credit rating. More likely to affect the credit rating would be company guidance for lower cash flows next year than rating agencies currently expect. Although in the short term, this would not change the material operations of the business, in the longer term, the company will struggle to be able to pay a dividend, cover pension liabilities, and cover the existing debt structure. Any material decline in operations is likely to warrant a credit rating downgrade and thus, the company's ability to obtain financing in the future or to refinance the massive debt load it carries. For stock holders and bond holders alike, a credit rating downgrade is yet another thing that could go wrong for R.R. Donnelley this week.
Although there are certainly many other wild cards that could pop up this week for the company, I'd like to highlight three. First would be the addition of more debt. Sometime in the next 14 months, the company has to figure out how it will pay $258 million in debt due on April 1, 2014. The current credit facility and cash on hand are both possible routes to take, but the company may offer more debt instead. This seems highly unlikely to me so far away from the due date, but it is something to consider.
Second is the possibility of the company putting itself up for sale. Earlier this year, the stock moved up on rumors the company was going to sell itself. In most instances, this would be viewed as a positive event, however, for those who have held the company's stock over the long term to collect the dividend, a sale would not get investors out of the hole unless the purchase price was extraordinarily above recent prices.
The last item that may be most likely as a wild card would be the announcement of additional charges. The company may consider closing facilities, impairing extra goodwill, or any number of other items, which would result in additional charges to be taken in 2013. An announcement of this sort may not change revenue, cash flow, or earnings, but any erosion in the company's equity at this point should create a big pocket of worry for stock holders and bond holders alike.
This article focused on things that could go wrong for R.R. Donnelley and Sons this week. The biggest worries I see are from lower than expected guidance, a drop in the dividend, and a credit rating downgrade. Any of these items is certainly a possibility, given the expected decline in the company's top and bottom lines. I will admit, however, there is still a strong possibility that nothing could go wrong this week. Earnings, sales, and cash flow could come out better than expected, guidance could be good, analysts and credit agencies could upgrade the company, and I could be in for a big surprise. But for now, I remain bearish on a company I think has no long-term value and will likely be out of business within the next 7-10 years.