Gannett's (NYSE:GCI) third quarter earnings are out and for the most part it's good news for investors. Part of Gannett's turnaround plan includes digital subscriptions for all of its newspapers, excluding USA Today. While the move will hurt advertising, it will stabilize subscription revenue. Several months into the hiring of Larry Kramer as USA Today publisher, Gannett appears headed in the right direction. I'll look at what the future holds.

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Publishing is by far the company's biggest revenue generator, and it's currently in the midst of a major turnaround. In September Gannett launched a new print edition of USA Today as well as a new website. At the time of the launch, Larry Kramer had this to say about the changes: "We are trying to think of USA Today not as a newspaper, but as a news company." To that end it is working with its papers across the country to share information and make all 82 of its newspapers and 23 broadcast stations a far more integrated news operation, while maintaining and enhancing its local coverage. To date it has rolled out paywalls at about 70 of the 81 papers (USA Today excluded) participating in the transition to digital subscriptions. As a result, the third quarter saw company-wide circulation revenue increase for the first time since early 2007. Skeptics will point to the 6.6% decline in advertising revenue in Q3 as well as a 32% decline in operating income as evidence the publishing unit is a long way from turning itself around. The turnaround plan was only agreed to in February, however, and Kramer was hired in May with USA Today editor David Callaway joining in July. A year from now if you don't see it making headway, then you could make a case, but at this point it's way too early for a verdict.


Gannett might not have TV station revenue like CBS (NYSE:CBS) or News Corp. (Nasdaq:NWSA) but it's equally important, perhaps even more so, to the overall health of its business. The third quarter delivered record revenue and operating profits of $237 million and $118.7 million respectively. Revenues increased 36% year-over-year and operating income 73.1%. Most importantly, operating margins were 50% compared to 39% in 2011. While the Olympics had a lot to do with its increased profitability, the first two quarters of the year saw healthy increases as well. In the first thirty-nine weeks of 2012, the broadcasting unit generated 55% of Gannett's operating profit from just 16% of the revenue. The broadcasting unit provides management with the breathing space to make the publishing changes necessary. Without it, Gannett would be sunk.


Although its digital segment is the smallest of its three divisions, it too is continuing to play an important part in Gannett's future. In the third quarter, revenues grew 4.7% to $182 million on operating income of $39.9 million, a 16.2% increase year-over-year. Most of this is attributable to strong growth at, North America's largest online job site. Digital revenues for all three segments increased 22.8% in Q3 to $334.6 million, representing 25.6% of its overall revenue. That's a 460 basis point increase from 21% at the end of 2011. Digital revenues produce greater operating margins. In the third quarter, they increased by 90 basis points to 16.6%, demonstrating why the push to fully digitize its business will be beneficial to Gannett in the long run.

The Bottom Line

A decade ago, Gannett's operating margin was 30%, double where it is today. In terms of dollars, it generated operating profits of $1.9 billion, again, far greater than today. Free cash flow is where the present compares favorably with the past. Its free cash flow yield today is 15.3%, compared to 3.9% in 2002. Its trailing twelve month free cash flow is $634 million, just $123 million less than in 2002, despite the fact revenues back then were $1.2 billion higher. Its free cash flow as a percentage of revenue is 12.2% in 2012, 40 basis points higher than in 2002. In addition its return on invested capital has remained the same despite deteriorating margins. This tells me it's doing a good job generating cash from its assets. In fact, it generates 9.8 cents in free cash flow for every dollar of assets today compared to 5.5 cents in 2002.

Gannett's dividend yield is currently 4.5%. Its free cash flow is $634 million. It has plenty of cash to keep paying the dividend and from where I sit, the business appears to be improving. Income investors should be taking a long look at its stock because the risk is far less than the media would lead you to believe and its future is getting brighter by the day.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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