Description

All amounts are in USD except references to share price.

Description:

Currency Exchange International, Corp. (CXI.TO / CURN) specializes in providing currency exchange and related products to financial institutions, money service businesses, travel companies, and other commercial and retail clients through its proprietary software platform, company-owned branches and vaults, and inventory on consignment locations throughout the United States and in Canada.

Thesis:

CXI incurred significant one-time expenses in FY-2023 but did not provide an adjusted earnings number or guidance for FY-2024. These one-time expenses are not easily discernible, but after adjusting for them, we estimate that earnings could have been ~40% higher. This suggests that CXI is trading at an undemanding valuation of less than 7x UFCF on a normalized basis. Additionally, the company holds a substantial 85% of its market cap in cash ($105M), providing a strong margin of safety. While most of this cash is used as working capital, we estimate the excess amount to be around $25M. Assuming modest growth over the next two years, CXI would be trading at less than 6x UFCF before accounting for any incremental cash generation (that they would likely allocate towards additional buybacks).

Many of you are likely familiar with this name or, at the very least, have seen it before, given the four prior write-ups it’s had in the last four years. Because of this, I won’t be deep-diving into each business segment, but I have provided a brief overview of each below.

Business Segments:

Legacy Segment (Banknotes) – 83% of revenues (~$68M):

Physical currency exchange business run through their retail locations and partnerships with “agents,” such as airport concession operators, who essentially franchise the CXI brand and technology. They also offer wholesale currency exchange services to banks and their customers (If you walk into a regional bank and need foreign currency, there’s a decent chance that currency came from or will come from CXI). Growth for this segment will come from general inflation, additional airport/retail locations, and additional banking relationships.

Payments Segment – 17% of revenues (~$14M):

“Fintech” business that offers currency exchange services to financial institutions, such as international wire payments, foreign check clearing, and FX hedging + risk management tools. This business was growing rapidly until recently (29% in 2020, 117% in 2021, 61% in 2022, and 15% in 2023), posting a -3% decline in the recent quarter. Despite this, the company continues to add new customers and process an increasing number of transactions (lower dollar amounts). Management believes that they can reaccelerate this business to a DD growth rate.

International Segment – de minimis % of revenues:

Physical currency exchange business dealing with international private/central banks. This business is essentially CXI shipping large amounts of physical currency to these banks. It’s worth noting that the customer pays upfront, meaning CXI has to allocate little to no capital here but still makes a spread on the exchange. This business has been years in the making and finally started to make some headway in early 2023 before the March banking crisis. Since then, the business has done essentially nothing in revenue since existing and new customers were reluctant to do business with CXI’s bank, given its small scale (despite having no deposit risk). However, CXI found a workaround by opening several trust accounts with much larger banks to help facilitate these transactions. This process took a good bit of time, but the trust accounts, as of writing, should be up and running, and the International business should start generating revenues again. From our understanding, several existing and new customers have been sitting idly, waiting for these trust accounts to open up. Furthermore, during this “downtime,” CXI didn’t just maintain its cost structure but grew it through several new hires focused on this segment and others (Salaries and benefits are up 20% y/y, and headcount is also up 12%). This bloated cost structure has had the negative effect of temporarily depressing margins in the short term. The company has a history of making these investments for the future despite the short-term pain they may cause, and we welcome this attitude as longer-term investors. Management has stated that they believe $500k a quarter in revenue growth for this business seems reasonable. However, a competitor, Moneycorp, grew their revenues by $20M in their second year of operation (to be fair, they benefitted from great timing + going after more risky geographies such as Africa). CXI won’t be growing their business at that rate and is going after more secure opportunities like Brazil. Still, with genuine pent-up demand from customers looking to diversify away from (or not serviced by) BOFA and Moneycrop, it seems likely that $2M a year could prove to be conservative.

Valuation:

CXI did ~$17M in EBITDA in FY-2023 (Adjusted for IFRS lease accounting), and I’ve broken out the one-time expenses below.

• ~$2.2M in stale dated items + stolen packages:
  • The stale dated items were a collection of very old checks (years) that they would have to go and bother their customers for (which in turn would make those customers have to bother their customers), so they decided it was best to write these down. It is our understanding that before their new ERP system, they did not have the best visibility into certain aspects of their business, but after implementation, they were able to tackle these. Additionally, through better fraud control, they identified mail workers who were cherry-picking out their packages to steal (these people have subsequently been caught and fired).
• ~$2.1M in normalized shipping cost:
  • This comes from a combination of adding another shipping carrier (UPS – saving $4 per package) and having customers pay for shipping costs followed by CXI reimbursing them later (rates are cheaper for the end customer than CXI, so CXI is catching a sort of mail arbitrage here). Normalized shipping costs should settle around 12-14% of sales moving forward, and as of the recent quarter, they sat at ~14% compared to ~18% in FY-2023.
•  $500K+ in ERP implementation cost:

Adding up the above gets us to ~$4.7M in one-time (or elevated) expenses they incurred during FY-2023 (we also believe these numbers could be on the conservative end of things). Throwing these expenses onto our FY-2023 EBITDA number gets us to Adjusted EBITDA of ~$22M, which translates to ~$15M in UFCF.

Put differently, just a normalization of the business would get you to ~30% EBITDA and UFCF growth. Furthermore, their adjusted EBITDA margins for FY-2023 would have been 26.5%, and we don’t believe that margin expansion to 30% is out of the question in the next 2-3 years. It’s important to note that they maintained all costs associated with the international segment in FY-2023 despite that business generating very little revenue and running in the red.

I am not certain what future growth will be, but I don’t think it matters at the current valuation. However, if we run with what management has stated for the International business ($2M a year) and payments (10% annual growth) and assume the legacy business can grow at 3%, that would get us to ~6% top-line growth.

Using that ~6% top-line growth number and assuming zero margin expansion gets us to ~$18M in UFCF sometime over the next two years. On an EV of $100M today, CXI can be bought for just 5.50x UFCF before any incremental cash generation. If CXI traded at 10x UFCF, it would be worth ~$43/share (~60% upside).

There is also plenty of achievable upside optionality here. If International were to add $10M in revenue over the next two years and margins subsequently expanded 150bp, they would do $20M+ in UFCF. Assuming a 10x UFCF multiple and throwing in an additional $25M of cash generation would imply CXI is worth ~$53/share (~100% upside).

Catalyst

International business grows faster than expected.

Continued share repurchases and expansion of existing NCIB.