It is a common view that the newspaper business is resilient because people read the papers every day, regardless of the economic climate. People want to know the latest happenings in good times and bad.

This is clearly a misconception. True, newspaper sales are unlikely to plunge sharply, unlike for products like cars or luxury goods. But print media revenue does not depend directly on newspaper sales. For newspaper companies, their bread and butter is advertising revenue. A free newspaper like theSun, which operates solely on advertising revenue, is a clear example of how the business works.

The deepening global economic crisis thus spells bad news for the newspaper industry simply because advertising expenditure (adex) is among the first items to be cut in the budget of any business.

Another serious threat is the growing migration of readers from newspapers to online news sites, draining advertising dollars. The closure of a growing number of newspaper companies in the US is evidence of this migration.

The print media is already feeling the pinch of the economic downturn. Newspaper adex has fallen for four consecutive months from October to January 2009. In January, newspaper adex declined 4% year on year to RM258.6 million while total adex for the media industry as a whole (TV, radio and print) inched up 2% y-o-y. This means that newspaper companies suffered a bigger blow than other media channels.

With luck, advertising revenue will see a single-digit drop, but in the worst-case scenario, it could be more than 10%. The adex of businesses shrank 17% during the 1997/98 Asian financial crisis, and if the current economic situation turns out to be severer, the contraction is likely to be worse.

A study by Carat Media Services (M) Sdn Bhd concludes that there is a correlation of 0.88 or 88% between adex and GDP growth, based on data spanning the past 12 years. It says adex moves in tandem with GDP at an average magnitude factor of 2.44. In other words, if GDP drops by 1%, adex falls 2.44% on average.

The government has forecast that GDP may contract 1% this year. The Malaysian Institute of Economic Research, however, expects the local economy to shrink by 3.8%. Based on that estimate, adex will dip 9.3%.

The “sell” recommendation of analysts on Star Publications (M) Bhd — the country’s largest and most profitable print media group — as well as other media stocks, such as Media Chinese International Ltd and The New Straits Times Press (M) Bhd, shows the prevailing pessimism on the industry’s earnings prospects in the coming quarters, if not years.

The latest Nielsen Media Report shows that Star’s gross adex dived 20.6% y-o-y in January.

Citi Investment Research’s analyst Alyson Shin has noticed that the page count for classified advertisements, which make up 25% of Star’s advertising revenue, has fallen 33% to 40 pages from 60 pages in better times.

Shin says Star has raised its advertising rates by an average 4% for both classified and display advertisements for the heavier days (Wednesdays to Saturdays). “However, this is unlikely to be sufficient to offset the drop in adex in FY2009. Factoring in the 4% ad rate hike, we still forecast adex to contract 12% in FY2009,” she comments in a February research report.

Although Star has been consistently paying dividends over the years, analysts do not see the stock as a safe haven due mainly to the media company’s profits being highly sensitive to the economic climate.

For years, Star has hoarded a substantial cash pile without declaring any hefty special dividend or making capital repayments, unlike other cash-rich companies such as IOI Corp Bhd and JT International Bhd prior to the crisis. In the current economic weather, the chances of Star paying out a special dividend are even slimmer as cash conservation becomes a priority.

Furthermore, the group’s RM250 million bonds are due for redemption next year. Its newly appointed executive deputy chairman Datuk Clement Hii says the group intends to utilise part of the cash reserves to redeem the bonds. “We will redeem the bonds next year because the fixed deposit rates are so low,” he tells The Edge in an interview.

As of Dec 31, 2008, the group’s cash balance stood at about RM612 million. The amount will come down to RM400 million after the bond redemption but the annual operating cash flow of about RM200 million — which could be less due to lower earnings — will help replenish its coffers thereafter.

Conserving cash is seen as critical, more so when the business has a high fixed cost structure. Over the past two decades, Star has grown by leaps and bounds in terms of earnings as well as manpower, after its English daily, The Star, overtook its main rival New Straits Times. As a result, the group’s fixed operating costs have ballooned. Its total operating costs, inclusive of printing and newsprint, have been above RM600 million in the past three years. This climbed to RM651.2 million in FY2008 versus revenue of RM831 million and net profit of RM138.9 million.

A high fixed cost structure is a blessing for the group when advertisers are fighting for space in the newspaper because the profit margin gets bigger as the advertisement ratio rises. This has been the case for Star over the past 10 years. It is the country’s most profitable newspaper with a handsome pre-tax profit margin of 24.2%, compared with its rival NST which manages only 9.5%. On the flip side, Star’s high fixed costs are a heavy burden, eroding its bottom line as costs do not fall fast when advertising revenue slides during an economic downturn.

However, Star is not suffering alone. The adverse effects of a high fixed cost structure is a common problem in the media industry.

Newsprint is the biggest cost component, accounting for about 35% of Star’s operating cost, followed by salaries at 21%. The falling newsprint price on the international market should help ease the cost pressure of newspaper companies in these trying times. However, Star is not able to enjoy cheaper newsprint due to its stockpile, says RHB Research’s David Chong.

Hii reveals that Star is sitting on 15 months’ worth of newsprint, which he describes as “too much”. Star’s latest balance sheet shows its inventories soared to RM214.9 million in FY2008 from RM161 million in FY2007.

“I am going to bring it down to six months and I am not going to buy more in the next eight or nine months. I want to conserve more cash. Since I came in, I haven’t made a single purchase,” he says.

It is difficult for Star to shine brightly in the current gloomy economic weather, but it can bank on its solid track record.

Since 1995, its net profit has risen each year except for FY1998. In the midst of the Asian financial crisis, its profit fell 25% to RM58.7 million in FY2008, but bounced back the following year to RM96.8 million. This fact may help sustain the confidence of the media giant in weathering the economic storm blowing now.

This article appeared in the Cover Story page, The Edge Malaysia, Issue 747, March 23-29, 2009