Fairfax's cost squeeze

Black would've been a great publisher for the Fairfax stable. And while they may be acting like they don't care now, the withdrawal was bitterly disappointing to Black and Colson. Despite the intrinsic value of these assets, we've been wary of Fairfax for most of the past two years, generally suggesting a neutral stance. And that's served us well, considering the trouble the share price has had holding its own recently.

Pulp non-fiction

Not that the last year or so has not been all right. In 1999/2000 sales rose 17.5% to $1.43bn, while net profit after tax before abnormal items rose 26.9% to $168.4m. The dividend was raised a cent to 11.5 cents, fully franked. Most of Fairfax's papers enjoyed advertising revenue gains in the order of 15%. So what does Fairfax have to worry about?

The most obvious concern on the cost front is the price of newsprint - the US dollar-denominated curse of any publisher's balance sheet. The world is currently experiencing a shortage of pulp, the raw material from which paper is made, and that's certain to have an adverse impact on costs even if a recent 10-year supply arrangement with paper producer Norske Skog guarantees price stability in the short term.

Just where we are in the economic cycle also needs to be considered. Sure, our economy seems very resilient at the moment. But, not too far down the track things will probably start slowing and, as fewer ads are placed, papers will be one of the first affected.

Another less pressing concern is the f2 internet venture. This is still burning up a lot of Fairfax's precious capital - 1999/2000 losses were $40.7m, and there's no sign of the venture getting into the black any time soon. However it isn't too bad - by and large Fred Hilmer's team have shepherded the company's capital with care, as indicated by the $130m reduction in long term debt, to $517m, in 1999/2000.

Now, in the long run we expect Fairfax will continue to go places. Its titles are too well established to be bitten fatally by the kind of sharks we've been describing. And Fairfax's present PER of 21 is not an unreasonable multiple given the growth in earnings enjoyed to date. We still think, however, that given the potential cost problems combined with the effects of a slowing economy, Fairfax may have trouble living up to double digit EPS growth prospects. With that caveat, the stock can be cautiously ACCUMULATED closer to $4.30.