JPMorgan reiterates neutral on Valassis

Valassis reported very weak Q3 results with EPS of -$0.11 vs. our estimate and consensus of $0.29. Revenues were down 7.2% with September accounting for all of the downturn; revenue growth was positive in July/Aug. Operating margin in Q3 was just 2.6%, down 550 bps y/y. The ADVO shared mail business led the far worse than expected performance with revenue down 6.7% with particular weakness from small business clients.

• Reduced 2008 guidance, 09 below expectations. With the shortfall in the quarter and weaker outlook, full year guidance reduced to $219m in adj. EBITDA from $260m-280m. Implied EPS comes to $0.58 from $1.11-$1.36. Q4 guidance calls for $65m adj. EBITDA and EPS of ~$0.28 (ex. $4m in restructuring costs). In 09, VCI guided to $215m in adj. EBITDA and implied EPS of ~$0.75 boosted by expectations for $50-60m in cost savings measures, though still below our recently cut estimates.
  

• Reducing estimates below guidance on caution over consumer spending, continued pressure on local advertising. Our Q4 adj. EBITDA is $55m and op. EPS of $0.16. We expect economic pressure on small businesses in particular will remain in Q4 and 09 which should be an ongoing source of weakness. Our 2009 estimates are EPS of $0.48 and adj. EBITDA of $195m.

• Debt covenants back in full focus. After building a healthy covenant cushion over recent quarters, Q3's weakness and gloomy outlook bring heightened concerns over VCI meeting its debt covenants through 2009. We expect Q4 is in OK shape though could necessitate some debt repurchases. In 2009, we expect that if business worsens and/or expected costs savings do not materialize, the company will need to seek an amended credit agreement or sell additional assets, such as its NCH coupon clearing business.

• Reiterate Neutral with caution toward Q4 and 09 performance. With shares down over 50% after the report we reiterate our Neutral stance. Despite VCI's attractive FCF generation - even in difficult times - shares are trading at 6.7x our 2009 EBITDA, a premium to the ad agencies which have a far better near and long term outlook, in our opinion. We remain concerned for performance into 09 and the company's ability to stay ahead of debt covenants.