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MagicDiligence (< 20)

Magic Formula Stock Review: Daily Journal (DJCO)



June 10, 2010 – Comments (0) | RELATED TICKERS: DJCO

Daily Journal (DJCO) has two different businesses. The first is the publishing of specialized newspapers, magazines, and websites that cover items of interest to the legal community in California and Arizona. The two largest publications, accounting for about a quarter of total revenues, are the two "Daily Journals", namely the Los Angeles and San Francisco Daily Journal publications. These two papers are published daily (obviously!), covering legal topics of interest to lawyers and judges. They also provide full text and summaries of California cases. Revenues are earned through both subscription fees, commercial advertising (mostly local businesses and law firms), and public notice advertising that is required by law. Some examples of public notice advertising are foreclosure notices and fictitious business names.

In addition to the Daily Journals, DJCO publishes a number of similar daily papers that focus coverage on either the legal and/or real estate professions. These papers earn their scratch in substantially the same fashion as the Daily Journals, but cover smaller subscriber bases. For example, the San Jose Post-Record focuses on the San Jose legal and real estate professional market. In total, DJCO publishes 12 daily papers of this nature, in addition to a couple of industry magazines. The publishing business, called the "traditional business" by management, accounts for close to 90% of revenues and effectively all of operating profits.

The second line of business is Sustain, which is a case management software system sold to courts and justice agencies. Sustain allows electronic management of case files and easier interaction with other interested parties. DJCO earns revenues here in two ways. In 2009, 54% of Sustain-related sales came from consulting/installation projects (basically new sales), while the rest came from recurring license and maintenance fees. Sustain is licensed in 11 states but the vast majority of sales come from California. The business has been minimally profitable, and there is no indication that management intends to focus on distribution expansion, so I won't comment much more on this line of business.

The outlook for the publishing business going forward is fair, but not great. DJCO has experienced strong operating results over the past 2 years, with operating margins leaping from a traditional 12-14% into the 30% range. The primary reason for this is the rapid increase in public notice ads related to foreclosures in California and Arizona - two of the hardest hit states during the real estate bust. This trend continues to be strong, but is clearly moderating, as revenues were down 5% in the most recent quarter and operating profits were flat. At some point, possibly in the near future, foreclosure notices will decline, and DJCO's revenue and profitability will follow suit.

This problem will be magnified by the fact that underlying subscription and advertising trends are not particularly great. Subscription volume and revenues have been steadily declining in the mid-to-high single digits annually. Competition is strong, as there are numerous low-priced competitors in California and websites continue to compete for recruitment ads. Accounting for the short-term phenomenon of foreclosure notices, I expect circulation revenues to decline at 4-5% annually, advertising to fall into the $17-19 million range (from $25 million currently), and Sustain to hold about where is is. A "normal" operating margin would be about 15%, putting operating income at a bit over $5 million annually.

Using these assumptions, earnings yield at $71 is 11.6%, not an expensive number but a far cry from the 32% that is currently being used by MFI. So, the stock is cheap, but not exceptionally so against reasonable expectations.

One other concern is the lightly traded volume on this stock. Outstanding shares are just under 1.5 million, and insiders own over 60%, making publicly traded float very limited. Average daily volume is just over 1,600 shares. If you do decide to purchase, be sure to use limit orders and be prepared to wait for orders to be filled.

A few things could mitigate these assumptions. First, the foreclosure notice business could continue to be strong for longer than expected, which would make the prior assumptions too conservative. Secondly, Daily Journal has been executing an exceptional stock investing operation on the side. During the market panic selling of early 2009, DJCO moved about $14 million in money they previously held in Treasury notes into common stock... and have subsequently booked a $37.7 million gain, helping to shoot cash and investment balances from $22 million at the end of 2008 to over $72 million currently! This stock investing arm is in good hands too. Daily Journal's long-time chairman and 41% stakeholder is none other than Berkshire Hathaway (BRK.B) vice chairman Charlie Munger.

To sum things up, Daily Journal is a decent but declining business that is an MFI stock as a product of the short-term foreclosure "boom" in California and Arizona, combined with some very shrewd stock investments. While this stock doesn't reach Top Buy status, the relatively cheap price and impeccable leadership make it okay to buy, in the opinion of MagicDiligence.

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