The printing industry has taken a big hit over the past 20 years across the board. Newspapers are in the dumps, with many barely surviving. Encyclopedias, atlases, and other staples of American households have gone digital. With the advent of e-readers, now books, magazines, and catalogs are all poised to go down a similar path as reference materials. These factors, combined with its balance sheet and earnings statement, leaves shares of R.R. Donnelley & Sons (RRD) and ideal candidate to short.
The Income Statement
The first item to scrutinize for RRD is the company's income statements of the past few years. After five years of revenue growth, the rapidly contracting economy of late 2008 and 2009 produced a distinct slowdown in sales for the company. In 2010 and 2011, RRD had a small comeback in sales, but never reached the peak of 2008. So far in 2012, the company has produced sales declines of 2% and 4%. Clearly the company has had problems producing growth in the top line.
Looking at the bottom line, there are three quarters that really stand out -- namely the fourth quarters of 2008, 2009, and 2011. Why has the company produced the largest sales amounts in these fourth quarters, yet has produced some outsized losses in three of the last four fourth quarters? The answer lies in restructuring and impairment charges, where the company is rapidly closing plants and shedding workers in order to keep pace with the rapid decline of print media. This leaves the trailing 12 months bottom line at a loss. Nothing on the earnings and revenue front points to a growing, solid company with a case for a higher price per share. The table below highlights the earnings of the last 14 quarters:
|EPS||EPS previous||% change||Sales % change|
|1st Quarter 2009||$0.07||$0.85||-92%||-18%|
|2nd Quarter 2009||$0.12||$0.69||-83%||-19%|
|3rd Quarter 2009||$0.06||$0.80||-93%||-14%|
|4th Quarter 2009||($0.38)||($3.24)||loss||-8%|
|1st Quarter 2010||$0.25||$0.07||257%||-2%|
|2nd Quarter 2010||$0.43||$0.12||258%||2%|
|3rd Quarter 2010||$0.25||$0.06||317%||1%|
|4th Quarter 2010||$0.13||($0.38)||vs a loss||5%|
|1st Quarter 2011||$0.16||$0.25||-36%||7%|
|2nd Quarter 2011||$0.07||$0.43||-84%||9%|
|3rd Quarter 2011||$0.79||$0.25||216%||8%|
|4th Quarter 2011||($1.65)||$0.13||loss||0%|
|1st Quarter 2012||$0.21||$0.16||31%||-2%|
|2nd Quarter 2012||$0.48||$0.07||586%||-4%|
The Balance Sheet
Next, let's look at the balance sheet. I will be using the year-end 2011 balance sheet, since the company tends to make large deductions in the fourth quarter of the year. The past two quarters have produced no more than a 3% change in any major balance sheet category.
Perhaps there is some real value in the company outside of earnings and revenue, or perhaps not. Right off the bat, a red flag goes up when I look at RRD's balance sheet. Current assets and total assets are shrinking, while current and total liabilities are increasing. This leads to a 53% decline in equity from year-end 2010 to year-end 2011 and less than $4.50 a share in equity. Without a doubt, a 53% drop in equity for such a large company is a very alarming figure.
Now let's look at the quality of the assets. The three big items of current assets for this company are cash, receivables, and inventory. All these check out as quality assets. Property, plant, and equipment of $1.85 billion is the major non-current, tangible asset. Based on previous depreciation expenses, this is set to decline around $400 million this year and render these assets nearly worthless in the next five or six years. If equity is only $1.06 billion, depreciation alone could eat away the remaining equity of the company in a matter of a few years.
Next we have goodwill and other intangible assets. The company has a whopping $2.8 billion of "assets" in this category, nearly three times equity, and down $500 million from the year before. These intangible assets will have to be written off over time as an impairment charge. Between the declining value of goodwill and property, plant, and equipment, the company could be in negative equity by the end of 2013. We will find out more when RRD recalculates the value of goodwill again in the fourth quarter of this year.
The debt picture is not any brighter than the assets and equity picture for the company. Through the end of 2015, RRD has over $1.2 billion in long-term debt maturities to pay off or otherwise refinance out of a total of $3.4 billion in long-term debt. With cash shrinking and under $450 million at the end of last year, RRD will have to find a creative way to raise money through selling stock, selling pieces of the company, or find an institution willing to loan it more money.
The good news, and perhaps the saving grace so far, has been a strong cash flow from operations, but this has not in any way contributed to strong cash on the balance sheet. The company may tout $500 million in share buybacks, but the company also borrowed $600 million in long-term debt. This does not enrich shareholders. At the end of the day, the company has less cash on hand than it did a year ago. It's the case of strong earnings, or strong cash flow, or strong earnings and strong cash flow. If companies don't have both, then there is no gain in equity for shareholders.
In all, the balance sheet of RRD looks horrendous and is getting steadily worse over time. Assets and equity are declining, while debt is still on the rise.
The Story of the Company, or Future Expectations
Unfortunately for fans of printed media like myself, e-readers and the digital age are quickly destroying the industry. Newspapers are practically obsolete, especially for the younger generations. Magazines are struggling and its much easier to browse a catalog or phone directory online than lug around a thick, heavy volume. None of these items bode well for RRD. The company has made some inroads through acquisitions in the digital media industry, but the bread and butter of the company remains printing.
Already with a big hit in sales for 2009 and once again declining sales in 2012, the company is reeling, trying to stay afloat. Cost cutting through the elimination of employees and plants is rapidly eating away at what's left of the business. The company eliminated its pension at the start of this year and has been eliminating its highest paid, most skilled employees. These actions parallel the decline of many other industries in the past as companies try to survive.
Conclusion and Brief Technical Analysis
With the prospect of negative equity by year-end 2013, if not by year-end 2012, there is no value left in RRD. With sales already declining and the world moving away from print media, there is little expectation, from my perspective, for raw earnings power to pull the company out of its downward spiral and deteriorating balance sheet. When looking for a short, this is one company to keep on your list.
Technical analysis of a nine-month chart shows the stock failing to reach levels earlier in the year during the mid-May through early August rally, even while the broader market has made multiyear highs. Last week's five-day rally on light volume brought the stock to just under the 50-day moving average, right below and in the area of some overhead supply created in early August. If the stock fails to break above the 50-day moving average or begins to decline from the $12 area, the company is not only a candidate for shorting over the long term, but is a candidate to be shorted rather more immediately.
Overall, the stock faces many hurdles in the future, and without a big positive catalyst could soon be heading to penny stock status. This decline may start sooner rather than later, with the poor chart created in last few months.
(Note: All company financial figures, except in the earnings and sales table, were obtained from RRD's 2011 annual report filed on SEC form 10-K.)