Australia's largest advertising and marketing group suffered its worse pounding in at least 14 years with its full year results missing just about every target set by the market.
STW Communications Group Ltd. (ASX: SGN) slumped a whopping 23% to a near six-year low of 79 cents in lunch time trade after management posted a 10.5% drop in underlying earnings per share (EPS) to 11.06 cents and slashed its final dividend by over a third to 3.5 cents a share.
This puts its full year payout to 6.8 cents when I was expecting a number closer to 8 cents on the back of my 2014 EPS forecast of 11.95 cents.
The bad news doesn't stop there. While normalised revenue is up 10.1% to $442.9 million, this is entirely driven by its acquisition of Active Display Group (ADG) in June last year. Organic growth actually fell 0.6%.
This has put pressure on margins. I was expecting some contraction and had penciled in about a 2.5% drop in earnings before interest, tax, depreciation and amortisation (EBITDA) margin compared to the 3% drop that was reported.
The fact is, margins are set to fall further due to a change in product mix. The acquisition of ADG makes STW a sizable player in the "shopper" space (this refers to the sales and promotion materials used in shopping aisles at supermarkets), and this industry is expected to grow faster than the other parts of the group.
The downside is that margins are a lot skinnier than those generated by advertising and marketing agencies – the traditional domain of STW.
Management dare not give a guidance except to say it was expecting low-single digit net profit growth for 2015. But given how many times management has overestimated profits since last year's result, the market will be taking that with a fairly large pinch of salt.
Even if management is right, this is bad news. Based on my estimates, STW will need to deliver greater than CPI-like growth within the next two years if it is to meet its debt repayment in 2017.
Unless there is a notable turnaround in conditions, there is a real risk STW will need to undertake a capital raising by this time next year unless it extends its debt profile.
I think taking on more debt is management's least favored option given its focus on paying down debt, which can be seen in the cut to its dividend payout ratio.
On the flipside, the stock is trading on an attractive valuation. Firstly, its trailing yield is over 12% if franking is included, and this will probably be sustained as long as earnings do not slip.
Second, the stock is trading at a 12% discount to my 90 cent discounted cash flow-based price target. Whether the stock can trade anywhere close to the price target is another matter given the market mistrust of the group.
Lastly, as I pointed out in late January, there is a likely chance STW could become a takeover target as its major shareholder, UK-listed advertising giant WPP Plc could make a play for the group.
As a shareholder, I certainly would be supportive of that after seeing the stock nearly halve over the past 12 months.
