RR Donnelly & Sons: Short Opportunity

The R.R. Donnelley & Sons Company (RRD) provides various print services to a wide variety of businesses worldwide, as well as, logistics and distribution services for print customers and mailers. It has a market capitalization of 4.32 billion and is, by far, the biggest player in the space. The company is carrying 3.62 billion in debt and, while many businesses like RRD are debt intensive, there are a number of conditions on the balance sheet that give reason for concern.

The “return on equity ratio” is a measure of the effective use of shareholder money and the current ROE is -20.2%. The profit generated from each dollar of asset value is the “return on asset ratio” and it is -6%. These are decidedly low rates of return and, generally, provide a picture of the efficiency of management.

On the revenue side, 3rd quarter earnings vs. the year ago quarter were -92%; profit margins are -6.23%; year over year revenues are -14%; and net income year to date vs. year to date is -89.5%. These figures speak for themselves and draw us to the question of how the company will deal with its high debt load.

The company’s “quick ratio”, a measure of short-term liquidity and the ability to meet its near cash obligations, is low at 1.05%. The “interest coverage ratio” is alarming low at -2.5%. A reading below 1.00% generally indicates that a company is not generating enough revenue to cover interest expense. The current dividend is $0.26, a yield of 5.00%, and that could be in jeopardy.

On the technical side the chart has recently started to show signs of deterioration. In the beginning of October we entered a period of channel consolidation.

The top end of the channel is $22.00 and it was tested many times in October and failed. It was tested, again, with the strong action in the first week of November, failed again, and appears to be setting up to test the low end of the range around $19.80.

The weekly MacD is rolling over and the daily RSI and MacD indicators are showing bearish divergences. The 13, 21 and 50 day moving averages are in confluence which often precedes a violent move in price. Money flow has been falling off since the start of this consolidation period.

The stock looks like a short candidate on a fundamental and technical basis and affords good entry and tight stop levels. The most recent close was $21.04, a break below the 50 dma at $20.38, would be a point to enter half of a short position with the stop above the 11/09 high at $21.25, risking $0.87. The second half of the position would be put on when the bottom of the channel was broken at around $19.70 with the stop now lowered to the 50 dma at $20.38. The risk on the second half of the trade is approximately $0.68 with the stop on the first half of the trade now at breakeven.

The problem with clearly defined patterns, like the channel with RRD, is that they are susceptible to false moves and head fakes. The “irrationality” of this market has been contagious with close correlation and the “rising tide” effect on diverse boats. The rule is always, trade consolidation patterns cautiously, trending patterns aggressively and preserve your capital.

Disclosure: Short RRD