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Torstar Corp. $21 – Toronto symbol TS.B

TORSTAR CORP. $21 (Toronto symbol TS.B (old symbol TS.NV.B); Conservative Growth Portfolio, Consumer sector; SI Rating: Above average) is one of Canada’s top media companies. It’s best known as the publisher of The Toronto Star, the largest daily newspaper in Canada. It also publishes over 150 daily and weekly newspapers in Southern Ontario.

Newspapers account for roughly two-thirds of the company’s revenue, and around 55% of its profit. The rest comes from wholly owned Harlequin Enterprises Ltd., the world’s largest publisher of romance fiction titles.

Torstar’s revenue grew slowly, from $1.42 billion in 2001 to $1.57 billion in 2005. These figures exclude revenue from discontinued businesses. In 2001, the company earned just $0.04 a share (total $3.0 million), mainly due to unusual items. Income in 2002 rose to $1.64 a share (total $125.3 million), but slipped to $1.59 a share ($123.5 million) in 2003. Restructuring costs cut Torstar’s 2004 profit to $1.42 a share ($112.7 million). In 2005, earnings improved to $1.52 a share ($118.8 million).

Unlike some newspaper publishers that saw the Internet as a threat, Torstar quickly developed its own web sites and invested in several Internet start-ups.

Some of these businesses failed, but others such as 40%-owned (an online job search site) and (a city directory) have become some of Canada’s most visited web sites.

Online ad demand growing strongly

The outlook for Torstar’s Internet division is bright. Many advertisers now prefer online ads over traditional print ads, since it helps them target certain buyers. Torstar’s strong content also attracts users to its web pages on a regular basis, which lets it charge more for online ads.

Profits from the Internet operations are still low, and ongoing investments in new ventures will probably hurt profits in 2006. But new businesses, such as the recent joint venture, should help Torstar take advantage of rising consumer interest in online classified ads.

Harlequin’s profits have suffered in the past few years due to the higher Canadian dollar. Harlequin gets most of its revenue from the U.S. and Europe, which means that its profits now translate into fewer Canadian dollars. Torstar uses hedges to cut its currency risk, but most of them expired in 2005.

New formats should spur sales

Harlequin hopes that investments in new formats will expand its sales and profits. These include large-print books, Japanese-style comic books based on Harlequin titles, and new series that focus on religious themes and other niche topics.

It also aims to sell more products through its web site, and make more titles available as downloadable e-books or audio books.

Torstar recently acquired a minority stake in Vocel, Inc., a U.S.-based developer of applications for wireless phones.

Thanks to this investment, Harlequin’s customers can now receive exclusive content and promotions through their mobile phones. Innovations like this should improve customer satisfaction and loyalty.

A few years ago, Torstar tried to launch its own TV station in Toronto, but lost the license to another company. The company felt that a TV station would cut its reliance on newspapers, and help drive more traffic to its web sites.

TV investment diversifies revenues

Torstar now plans to pay $283 million for 20% of Bell Globemedia, the partnership that controls CTV Television Network, The Globe and Mail newspaper, and several specialty TV channels.

Torstar’s strong balance sheet and steady cash flow help it afford these new investments. Long-term debt is a reasonable 0.4 times equity, so it can easily borrow more if it needs to.

However, goodwill is a high 35% of assets, mainly due to its aggressive acquisition strategy in the past few years. If these investments fail to live up to expectations, Torstar will have to write off part of this goodwill, which would cut its earnings.

Torstar’s stock got as high as $32 in early 2004, but has moved down steadily due to concerns over the future of the newspaper industry.

The spread of free commuter newspapers (including Toronto-based Metro, 50%-owned by Torstar) is also cutting into sales of The Toronto Star. But Torstar’s community newspapers face little competition, and should generate strong cash flows for years to come.

We like the p/e and the yield

Torstar will probably earn $1.21 a share in 2006, and the stock trades at 17.3 times that temporarily depressed figure. It also trades just above its revenue of around $20.00 a share. The $0.74 dividend seems safe, and yields 3.5%.

Torstar is a buy for income and long-term gains.

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