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Can we trust STW Communications Group Ltd. to pay a 10% plus yield?

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Shares in embattled STW Communications Group Ltd. (ASX: SGN) rallied this morning after management succeeded in negotiating improved terms for its debt covenants and announced a cost-cutting drive.

Shares in the advertising and marketing group surged 4.6% to 57 cents as the market is relieved to hear that its covenant headroom will fall to 2.5x net debt-to-earnings before interest, tax, depreciation and amortisation (EBITDA) from 3x.

STW is aiming to lower the ratio to 2x net debt-to-EBITDA and is targeting $7 million in annual cost savings as it looks to streamline its disparate businesses through consolidation and divestments.

The stock has shed nearly 60% of its value over the past year and is trading at a discount to my calculation of fair value because of fears it will need to undertake a capital raising to avoid breaching its debt covenant.

Making matters worse, the group has borrowed heavily to finance acquisitions but these acquisitions have not turned the company’s profits around with management admitting that it has been slow to react to industry changes as it lost a number of key clients.

But STW is promising it has seen the errors in its ways and is trying to win back the confidence of investors. Reiterating its 60%-70% dividend payout ratio is a good first step as it implies it can still potentially generate a more than 10% yield.

This, of course, assumes there isn’t another profit downgrade in the wings.

I take some comfort that there was no revision to guidance in today’s investor presentation, although we cannot rule out one later this year as the group’s financial year end is in December.

Changes in the advertising market that are driven primarily from the shift to online and mobile has hurt media companies with Nine Entertainment Co Holdings Ltd (ASX: NEC) the latest to issue a profit warning yesterday.

STW should be better placed to meet the changes through its established advertising agencies but the group has so far been unable to ride the wave of change as client budgets have shrunk and management expanded into lower margin businesses.

The stock is looking cheap but it’s only suited for those with a higher tolerance for risk.

Management has bought a bit of time. Let’s hope they use it wisely.

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Motley Fool contributor Brendon Lau owns shares of STW Communications Group Ltd.. Follow me on Twitter - https://twitter.com/brenlau

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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