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 AJR  Columns

From AJR,   June 1999  issue

Everything Is Coming Up Profits for Papers   

Plummeting newsprint prices mean healthy bottom lines.

By John Morton
John Morton (mortoninc@msn.com), a former newspaper reporter, is president of a consulting firm that analyzes newspapers and other media properties.     

NEWSPAPERS THIS YEAR are enjoying the best of all possible worlds for making profits--reasonably strong advertising performance and rapidly falling newsprint prices.

This happy combination has already helped produce strong first-quarter earnings' growth, with operating income of publicly reporting companies up an average 8 percent over the same quarter last year. (Operating income is the money a company earns before paying interest and taxes.) Revenue overall was up 4.7 percent. In the same quarter last year, when revenue rose more than 7 percent, operating earnings grew a shade under 5 percent.

Newsprint, you may recall, is that somewhat unpredictable and major operating cost (about 20 percent of all costs on average) that allowed newspaper profits to soar from 1992 through 1994, ate up profits in 1995, then helped profits soar again in 1996. Since then and until early this year, prices were relatively stable, in the range of $550 to $600 a ton.

But early this year, prices began to plunge and as of this writing had dropped as low as $500. One Canadian paper analyst estimates prices are dropping about $20 a month, with the bottom not expected until midyear. The price might even get down to $425, the same as the last price trough in 1994.

The sharp ups and downs in newsprint prices over the last several years mostly reflect imbalances between supply and demand and what I refer to as the "hog farmer" mentality of newsprint producers. When hog prices are high, farmers tend to breed more hogs than usual, hoping to cash in on the high prices. Of course when all these hogs are born, reared and brought to market at the same time, the market becomes awash in hogs and prices plunge.

Replace hogs with investment in new newsprint production capacity and you pretty much get the picture of supply and demand imbalances in the past. What's different about the cycle this year is that significant new production capacity has not come on line. No, newsprint producers have taken careful aim at their own feet and pulled the trigger.

Despite continued weak newsprint demand from the economically troubled regions of Asia and South America, which normally take some North American production, and despite the prospect of only modestly increased demand in North America, the producers have kept their existing mills running flat out. The natural result is oversupply, with unsold newsprint piling up at the mills and with, you guessed it, falling prices.

Now there are some factors that could halt the price plunge. Some producers recently announced production cutbacks, although so far not by much and not soon enough to have a significant impact on supply for months. When the price hits rock bottom, newspapers are likely to start stockpiling newsprint; this, too, will take some time to have an effect.

In the last half of this year, Year 2000 promotions and special sections likely will boost newsprint consumption above what would normally be required by advertising growth. (Circulation, the other component that drives newsprint consumption, is not likely to contribute much given its waning performance.) Finally, there are signs that demand in Asia is starting to pick up a little.

However these factors play out, it's pretty clear that newspaper earnings for most of the year will get a big boost from cheap newsprint, especially if the economy stays on its present path and advertising continues to grow. (First-quarter ad revenues were up 6 percent over the same quarter last year.)

Thus the newspaper industry seems destined to have another year of high profit margins. Last year, the publicly reporting companies, which with more than 40 percent of national daily circulation are a suitable proxy for the industry, had an average operating profit margin of 20.7 percent. That was just slightly under 1997's average profit margin and not much below the record 22 percent set in the mid-'80s.

Indeed, even in 1995, when newsprint prices were at their highest, the industry still managed an average operating margin of 14.5 percent--not bad when you consider that the Fortune 500 falls slightly below that even in a good year.

The ability of newspapers to throw off so much profit even in adversity is the principal reason for the high values placed on newspapers in the mergers-and-acquisitions market.

Despite all the talk about the newspaper industry being a mature one with doubtful growth prospects--an industry beset on all sides by the Internet and other competitors--individual large newspapers have sold for considerably more than a billion dollars. Entire airlines have sold for less.