Newspaper rally? Curb your enthusiasm

After some notable newspaper publishers this month reported better-than-expected gains in their second-quarter net profits, Wall Street responded by bidding up their battered shares. But let’s not get carried away.

The improved earnings reflect one-off events that for the most part cannot be replicated if sagging ad sales fail to rebound really hard, really fast and really soon. In other words, publishers are running out of magic at a time when there is scant evidence that ad sales are headed for the sort of dramatic turnaround that would restore the industry to its former vigor.

Things certainly looked encouraging when some of the leading companies reported their second-quarter earnings. Gannett swung to a net after-tax profit of 30 cents a share from a loss of $10.03 per share in 2008; McClatchy more than doubled its earnings to 50 cents a share, and the net at the New York Times Co. leaped 85% to 27 cents.

The performance boosted the depressed shares of the companies to some of their highest levels this year. Gannett closed Wednesday at $6.26 per share but still well below its 52-week high of $21.68, McClatchy closed at $2.27 vs. a 52-week high of $4.90 and NYT closed at $7.52 vs. a 52-week high of $16.75.

But a closer look at the operating performance of the three companies shows that none was able to cut its expenses deeply enough in the first half of the year to stay ahead of the catastrophic revenue declines eroding their operating margins.

Gannett in the first six months of 2009 reduced expenses by only 10.1% as sales fell 17.8%; McClatchy pared expenses by 20.6% as revenues dropped 25.3% and NYT trimmed spending 15.3% as sales slid 19.9%.

Consequently, the earnings of the companies before interest, taxes, depreciation and amortization fell by respectively 41.6%, 35.5% and 64.6% from the first half of 2008. This put EBITDA in the first six months of this year for Gannett at 17.3% vs. 24.3% in 2008, McClatchy at 15.3% vs. 17.7% and NYT at 4.1% vs. 9.4%.

The improved after-tax earnings of the companies that grabbed he headlines, as the publishers forthrightly explained in each of their financial reports, resulted from such singular events as debt restructurings, tax credits, the disposition of non-core assets and other legitimate – but non-recurring – adjustments.

The performance of Gannett and McClatchy compared favorably to the prior year, because they were not required in 2009 to take sort of heavy losses on overpriced assets that accounting rules required in 2008.

Battling to trim expenses as sales plunged by double-digit levels in the worst economy since World War II, publishers have resorted to heretofore unthinkable cost cutting.

They pared staffs, throttled newsprint consumption, outsourced customer-service operations and consolidated production facilities. The full extent of the savings in some cases will not be revealed until future periods, when lingering shutdown costs and severance payments no longer affect earnings.

As much as these measures helped bolster profits, they are one-time expediencies that cannot be repeated if sales continue to fall in the future at anything like the rate they have been dropping in recent years.

It is impossible to fire an employee who already has been fired, to eliminate a weekend supplement that already has been discontinued or to idle a press line that already has been scrapped. That’s not to mention such unrepeatable maneuvers as eliminating print production on certain days of the week, migrating to web-only publication or shutting a paper altogether.

To be sure, there are those who believe the expense reductions will position newspapers to prosper if ad sales perk up as the economy recovers.

“With all the cost cutting, you just have to have some reasonable growth in revenue and you’ll have spectacular earnings growth,” said John Rogers Jr., the chief executive officer of Ariel Investments, in an interview with Bloomberg News. “This economy is going to recover and people are going to advertise again.”

Rogers has put his money where his mouth is. Though he rode the shares of a number of newspaper companies down from all-time highs to record lows, he remains today the largest stockholder in Gannett and the second-biggest shareholder at McClatchy.

It would be nice if he were right. But he may be underestimating the challenges the newspaper industry faces as it seeks to recover from an accelerating decline in sales that began in April, 2006 – well before the economy unraveled.

When the economy turns around, a good number of traditional newspaper advertisers – bankrupt retailers, de-franchised auto dealers, out-of-business employers and belly-up real estate agents – won’t be there to join in the recovery.

So, you have to wonder not only when advertising will come back but also how much of it will.

You also have to worry about whether the extreme cost cutting has irreversibly damaged the appeal of newspapers.

As Ken Doctor noted in this excellent analysis at his Content Bridges blog, perhaps 828,000 stories per year are not being produced by American’s down-sized newspaper industry.

Newspaper readers, who by definition are among the most thoughtful members of society, are perceptive enough to know they are paying more today for newspapers that deliver far less news and advertising than ever before. They are doing so, to the extent they are doing so, in the hopes they can help the industry survive.

But their patience will not be infinite. If newspapers can’t find a way to do better by their readers, they are in danger of slashing themselves to oblivion.