And Then the Bottom Fell Out of Torstar

Includes: BMO, TORSF
by: Mark McQueen

I know that most of you are tech stock holders, but you can’t help but ask yourself what is going on with the good ship Torstar [TSX:TS.B](OTC:TORSF). A 4% one-day drop is not something we are used to seeing in mid cap land, particularly when the stock in question is of the “value” kind.

The recent first quarter results were tough, reflecting the world of many newspaper proprietors. Restructuring charges, layoffs, a net loss. None of it good for the stock.

But today’s action reflects something different. A darker mood. A 500,000 share block traded this morning in and around $13.13. That’s a big cross for this name, and the stock didn’t trade up from there. Normally, when a capitulation trade comes to pass, the stock bounces up in the hours that follow. That didn’t happen today. ;-(

What that means is this: Torstar shareholders and Bay Street prop traders don’t think the beating is going to end just yet. As a result, the stock closed below $13 for the first time since I started watching the quote circa 1997 (I was a Star paperboy in 1976-78, but was more interested in cars, photography, girls and hockey than the price of Torstar shares).

At least one or two things are undoubtedly troubling investors. First, the outlook for North American newspaper companies is cloudy at best, as more and more advertisers transition part of their spend from the DTM to online avenues.

Second, and specific to Torstar, there’s the tricky issue of the dividend. At today’s close, the implied annual dividend is a juicy 5.7%…if you believe that Torstar can continue to pay a divi of 18.5 cents a quarter. When things got bleak at the Canadian banks a few weeks ago, Bank of Montreal (NYSE:BMO)’s dividend rate touched 6.5%, for example. It even got close to 7% before the stock rallied from the $38 low to its current $50+.

In BMO’s case, many of us were convinced that the bank wouldn’t have to cut the dividend (”Enough with pounding the CDN banks” March 6-08), and that the 6ish yield was a great safety net; BMO shares couldn’t break through that level so to speak.

In Torstar’s case, the market may not be so sure. For Torstar’s dividend to imply a 7% annual yield, TS.B shares would have to trade down to about $10.60 - a meaningful drop from the current price. But that really isn’t what’s driving the stock.

A key worry must be that Torstar will not be able to maintain the dividend in light of the most recent quarterly financial performance. One quarter does not a lifetime make, but Torstar’s bankers will no doubt have noticed that in the first quarter, total debt rose $19.1 million, which is not far off the ~$14.6 million that went out the door in the form of dividends to shareholders.

A $20 million restructuring provision might not have helped debt levels, but it is hard to know how much of that was actually a cash drain in Q1. $13 million of depreciation, but only $4 million of hard capex was a timely event. But non-cash depreciation charges that are 3x your capex aren’t sustainable in any capital equipment intensive business.

If there is one thing that ruffles a traditional bankers’ feathers it’s the idea of using low-cost debt to put money into the jeans of common shareholders. With the dividend representing two-thirds of the increase in quarterly debt, the bankers will be watching those figures like a hawk, even if the collateral is fantastic; which it is in this case.

With a diverse portfolio of valuable assets, Torstar management have plenty of options. The stakes in Black Press and CTV GlobeMedia are not core, for example, even if they are justifiably prized possessions.

With a bleak macro picture, the pressure is clearly on the management team, the Board, and the Voting Trust. But the free cash flow is something to watch.

As is the dividend. The two are more connected by the day. And now the stock price will swing with the mood of those who think the 18.5 cent quarterly dividend is at risk.

Disclosure: I own BMO.