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 sales are still derived from print media. Since the last article I wrote on September 11, 2012, the company has had its unsecured debt downgraded by all three major credit ratings agencies. This article will focus on reviewing these downgrades and review the strategy of buying and/or holding RR Donnelley for its 9.4% yield (as of 9/24/2012 close).
The Ratings Downgrades And The Unsecured Debt
All three ratings downgrades were a result of the company restructuring its revolving credit facility, from unsecured to secured, meaning the new facility now takes priority over the unsecured debt. Additionally, Fitch downgraded the Issuer Default Rating and Moody's downgraded the Speculative Grade Rating. The immediate impact of these ratings downgrades will be minimal as far as I can tell. From the 2nd quarter 2012 10-Q
As a result of the June 13, 2012 downgrade by Moody's, the interest rate on the Company's 11.25% senior notes due February 1, 2019 was further increased from 11.75%, as of the May 16, 2011 downgrade by both of the rating agencies, to 12.0%. The August 1, 2012 downgrade by S&P will increase the interest rate on these notes from 12.0% to 12.25%.
The debt affected by the prior downgrades totals only $172.2 million out of over $3.7 billion in total debt as of June 30, 2012. Even a full 1% increase in interest rates on this debt would only result in about a $0.01 per share decrease in annual earnings, based on 180 million shares outstanding. After combing through prior SEC filings, I see no mention of other debts being impacted by prior debt downgrades. Assuming these are the only debts affected by the current round of downgrades, there should be no material change in the business as a result of the ratings downgrades. However, after three rounds of ratings downgrades this year and the addition of a secured revolving credit facility, one can imagine future attempts at obtaining unsecured debt will be greatly hindered and at a much higher interest rate than obtainable in the past.
Here is a table summarizing the last two rounds of downgrades by the ratings agencies:
|Rating Agency||What was cut||New rating||Old Rating||Date|
|Fitch Ratings||Issuer Default Rating and senior unsecured notes/debentures||BB||BB +||September 24th|
|S&P||Recovery rating on existing senior unsecured debt||4 (30-50% recovery)||3 (50-70% recovery)||September 19th|
|Moody's||Unsecured notes and speculative grade rating||Ba3 and good liquidity||Ba2 and very good liquidity||September 19th|
|Fitch Ratings||Rating Outlook||Negative||Stable||August 8th|
|S&P||Corporate credit rating and Senior Unsecured Debt||BB||BB +||August 1st|
|Moody's||Corporate family rating, probability of default, unsecured debt||Ba2||Ba1||June 13th|
Source: Yahoo news headlines
Another important part of these downgrades is the rationale presented in the text by the ratings agencies. The Moody's text is not readily available through traditional news outlets, but can be found on the Moody's site, where one can register for free. The S&P text and the Fitch text are readily available and both agree on several core items relating to the company's financial performance. Both agencies agree with the company's projection of around $300 million in free cash flow (FCF) for 2012, and both agencies expect single digit sales declines with flat EBITDA for 2012. These numbers do not differ from the last downgrades issued by the agencies. S&P goes one step further and expects flat to single digit sales declines in 2013, while also predicting a decline in EBITDA in 2013, reversing any margin gains made in 2012. These outlooks are in line with what has been expected out of this slowly declining business.
Essentially, these downgrades do little to change the outlook of the business, nor the outlook for most of the existing debt. If anything, the holders of the notes due February 1, 2019 are going to get a higher interest rate. However, as all three ratings agencies note, this all hinges on a continued emphasis on debt reduction by management and only a single digit decline in revenues and EBITDA. If the decline should accelerate or the company has trouble reducing debt, ratings will drop further. The opposite may also be true. If RR Donnelley could somehow manage to grow its business amidst such strong adversity in the industry, ratings would improve and the company's outlook improves dramatically.
The Case Against Buying For The Dividend
In my last article on RR Donnelley, I forgot to include a discussion of the dividend, which was pointed out in the comments made by others. To me, there is no rational reason to hold the company's stock in order to receive dividends, as long as the company is still in decline. In order for one to truly reap a reward on dividends, one must also at least maintain the same level of capital. In other words, if the stock is dropping faster than the dividend payout, then one is still losing money on the investment. The following table outlines the net losses one would have incurred by investing in RR Donnelley on September 24th, or the last market day if the 24th was on a weekend, for each of the last ten years.
|9/24/2012 close||$ 11.03|
|Year||Price||Dividends Since||Decline In Price||Total Loss Per Share|
|2011||$ 13.89||$ 1.04||$ (2.86)||$ (1.82)|
|2010||$ 17.66||$ 2.08||$ (6.63)||$ (4.55)|
|2009||$ 20.86||$ 3.12||$ (9.83)||$ (6.71)|
|2008||$ 24.88||$ 4.16||$ (13.85)||$ (9.69)|
|2007||$ 35.38||$ 5.20||$ (24.35)||$ (19.15)|
|2006||$ 32.84||$ 6.24||$ (21.81)||$ (15.57)|
|2005||$ 36.20||$ 7.28||$ (25.17)||$ (17.89)|
|2004||$ 31.70||$ 8.32||$ (20.67)||$ (12.35)|
|2003||$ 23.64||$ 9.36||$ (12.61)||$ (3.25)|
|2002||$ 23.08||$ 10.37||$ (12.05)||$ (1.68)|
As one can clearly see, before paying taxes on the dividends, an investment on this date any time in the last ten years would have resulted in a loss. Throw in taxes, and the loss increases.
With the ratings agencies expecting a decline in sales and earnings and there being no room in credit facilities for an increase in dividends, there is little to fuel the fire of a bullish stock. The average analysts' opinion from Yahoo roughly agrees with the rating agencies, projecting a slight decline in sales this year and flat next year. As I mentioned in my previous article, the latest reported fiscal year end 2012 featured a decline in assets, an increase in liabilities, and a 53% decrease in shareholder equity. None of these concepts would lead me to believe the stock is in for a big run in the near future. Indeed, the only case for an upward moving stock I have seen is the yield, which may eventually produce a general floor in the stock's price. However, if general business conditions continue to deteriorate to a point where the company can no longer cover debt payments, the first thing to go will most assuredly be the dividend.
The recent downgrades do not change my opinion of the company and they seem to be a non-event for most stakeholders. With print media suffering year-over-year declines, there is little in the way of a growth prospect for RR Donnelley. The logistics services and digital media products of RR Donnelley remain a very small part of the business. Although some may be excited by the recent acquisition of Edgar, this company will contribute a scant $55 million a year, give or take, to 2013 sales, assuming its previous projected growth rate of 35% is obtainable. The digital acquisitions of RR Donnelley are not contributing enough to offset the sales declines of print media. The only justifiable reason to buy the stock is the yield, and after this justification, one must hope the stock does not continue to fall and erode any gains from the dividend payouts and one must also hope the company does not cut the dividend. Investing for the dividend's sake is a high risk venture, though if these holders are right they will reap high rewards.
I remain bearish on the stock in the long run and will remain so unless there is a material change in the company's business. In roughly five weeks, we will get another update on the company's business when quarter three earnings are released. If sales were to show an increase in the 3rd and 4th quarter and no major restructuring or impairment charges were included in the 4th quarter release, I would change my long-term opinion of the company's stock.