Description

Consolidated Graphics, Inc. (NYSE: CGX) is the largest sheet-fed commercial printing company in the U.S., and is the fastest growing. Value investors will find this stock compelling for the following reasons:

(1)CGX is undervalued relative to both the market and its industry peer group; (2) CGX continues to throw off large amounts of free cash flow which can be used for further share repurchases; (3) The commercial printing industry (which is still extremely fragmented) will further consolidate due to expensive technological advances in digital printing which smaller operators cannot afford, and whose improved capabilities customers demand; (4) CGX's new "CGXmedia" e-business group will further leverage economies-of-scale for its growing list of large national account clients; (5) Commercial printing should be among the first industries to benefit from an eventual upturn in the economy, wih CGX set to feel the impact first.

CGX provides full and half web printing, fulfillment, direct mail and internet consulting services for a customer base of 10,000 firms. Its high-quality color printed products represent some of the most recognized companies on earth. Among the oldest and largest of U.S. industries, comercial printing is dominated by 37,000 small and mid-sized businesses, mostly privately owned. Only 3% of all printers enjoy $35 million or more in annual sales, making this inustry a natural rollup candidate. Past attempts at rollups in industries ill-suited for consolidation (e.g., Family Golf Centers, Total Renal, Spin Cycle, etc.) however cast a pall over all such stocks, regardless of their underlying business fundamentals. This investor prejudice (like the previous one against REITs) creates value opportunity in the meantime.

CGX enjoys a national footprint through a network of 63 locally managed printing companies in 25 states, offering a full range of traditional printing services (i.e., electronic presses for document printing, finishing, storage and delivery), as well as online communication and fulfillment.

I first became aware of Houston-based CGX on October 18th, 1999 when a selling climax of 18 times its normal trading volume wiped out one-third of its market value in a single day. Hurricane Floyd had disrupted 20% of its operations the previous month and would cause Q2 EPS to miss the $0.74 the Street expected. Jittery investors panicked, dumping the stock en masse. Now 22 months later, from a technical point of view, CGX shares are solidly in turnaround mode and seem headed for $40. Currently trading at $22 and below book value, CGX is still 70% off its all time high of $74.50 set on January 26th, 1999. Enough "dead mony" time has elapsed: now is the time to finally jump in.

By many measures of value CGX shares are cheap, especially when compared to its peer group. CGX price/sales ratio is 0.42, its price/book is 0.97 and its price/cash flow is 4.85. By contrast, prnting services industry rivals like Multi-Color Corp. (LABL: with price/sales of 0.67, price/book of 3.30, price/cash flow of 11.31), R.R. Donnelly & Sons Co. (DNY: with price/sales of 0.66, price/book of 4.01, price/cash flow of 6.40) and Schawl Inc. (SGK: with price/sales of 1.22, prie/book of 3.58 and price/cash flow of 11.08) ALL trade at higher values. Thus the industry leader is now selling to a discount to its slower growing rivals.

CGX's PE is 15, its quick ratio is 1.54 and long term debt/equity is a managable 0.81. Five year CAGRs for sales and EPS are 52% and 36%, respectively, yet CGX's market cap is still below $290 million - probably because only one Wall Street analyst follows it. EPS (before special charges) have surprised to the upside for each of the past three quarters (as much as 44% beyond estmates).

Have no illusions as to the company's ability to continue to grow through rough times. CEO Joe Davis founded CGX in Houston in 1985 - amidst the great Texas oil bust - with one print shop and has been skillfully acquiring owner-operator targets ever since, dropping low margin business lines and ruthlessly squeezing out inefficiencies. Revenues have grown nearly eightfold since 1996, and net income tripled between 1997 and 1999. Sales for the first half of 2001 have dipped below 2000 level, yet profits continue to pile, albeit more slowly.

CGX just announced Darrell Whitley would head up its rapidly growing online group, CGXmedia. Management sees two of its new services - "COIN" (a secure online print ordering and fulfullment service) and "OPAL" (a digital assistant management service) - as especially attractive to large national accounts, seekin to simplify their own operations. CGXmedia should be a key driver to reaccelerate revenues when the general economy finally turns around.

Catalyst

I expect CGX shares to appreciate 100% or more from current levels within 6 to 9 months due to: (1) value stocks continuing to attract greater attention during the current market slump; (2) rollups which can execute properly (like United Rentals) even under tough onditions gaining more analyst visibility; (3) further printing industry consolidation will boost CGX's marketshare and profits; (4) new online services will attract bigger, more lucrative, national accounts; and (5) an upturn in the economy will benefit all commerical printers.