Description
In the nearly three years since the S&P 500 peak in March’00, DLX has doubled. A compelling case can be made that the stock retains very significant appreciation potential in the context of exceptional risk/reward.
DLX is the largest check printer in the world and provides checks, business forms, and related products to banks, other financial services companies, consumers and small businesses through three business segments: Financial Services; Direct Checks; and Business Services. Financial Services provides checks and related products and services to financial institutions. Direct Checks sells checks and related products directly to consumers through the mail and Internet. Business Services sells checks, forms and related products to small businesses on behalf of financial institutions and directly.
Although DLX, like most companies, must contend with its share of both cyclical(muted demand) and secular(lower check volumes due electronic payments) forces, it is distinguished by numerous positive attributes. It has clearly the premium/preferred products in its space and this has enabled modest unit growth and stable pricing despite the aforementioned forces. Most importantly, against a back drop where all too often corporate managements have unrealistic growth expectations for their company and vaporize capital in search of it, DLX has a management that recognizes both the maturity of its business and its prodigious and stable cash flow and capital generation capabilities and is absolutely dedicated to its re-deployment for shareholder benefit.
A distinct catalyst for the recent share price performance was the Winter ’01 decision to repurchase 12 MM shares(on a then 74 MM share base) due management disciplined determination to forgo acquisition or other investment opportunity failing the duel criteria of very high hurdle rate of return and immediate cash flow accretion with limited risk. DLX would dedicate substantially all of its FCF to share repurchase. Through a combination of margin enhancing efficiency programs(along w/ modest unit demand and stable pricing) and share repurchase, DLX has grown earnings from $ $ 2.44 in ’00 to $ $ 3.31 in ’02 and has grown free cash flow per share from $ 1.24 in ’00 to $ 2.28 in ’02.(Recall our FCF definition is CFO – capex – dividends). In addition, investors have collected a hefty $ 1.48 annual dividend.
DLX completed the 12 MM share repurchase program in 3Q02 and, shortly thereafter, by way of encore, pursued a modest re-capitalization(EBITDA is approx. 420 MM) of the Company by assuming 300 MM in long term debt at a modest 5% interest rate and will use this, along with its approx. $ 145 MM per year in FCF to repurchase another 12 MM shares from what was a Dec. ’02 share base of 61.44 MM. Assuming, for the purpose of the analysis, that the company buys 6 MM shares in each of ’03 and ’04, e.p.s. will grow to $ 3.54 in ‘03(a figure management has endorsed) and $ 4.00 in ’04. More importantly, the Company will realize 25% accretion in FCF/share as it rises from $ 2.28 in ’02 to $ 2.90 in ’04.
DLX is valued at a very modest 10.7X on a P/E basis, 5.8X on an EV/EBITDA basis, has a dividend yield of 3.9%, and a FCF yield of nearly 6%. Thus, with implicit support for the share price at the current level via the near 4% dividend and the fact that the Company will repurchase 20% of the outstanding shares in coming quarters, investors can buy a stock with ‘cash on cash’ return of 10%(dividend yield + FCF yield).
At end ’04, if DLX has sustained its trailing P/E of 11.5x, the stock will have appreciated to $ 46 which, when combined w/ 1.75 years of dividends would bring a total return of 28% over the 21 month holding period. This is hardly shabby in a low return world.
At the same time, and similarly, if DLX was still valued at a 6% FCF yield, with then approximately 49.44 MM shares outstanding, the stock would be valued at approximately $ 45 and thereby bring a substantially similar total return.
On the other hand, should more investors recognize the magnitude and stability of FCF at this Company and come to appreciate management’s motivations and, as a result, value the stock at a still modest 5% FCF yield or 6.5X multiple of EBITDA, DLX would appreciate to the low/mid $ 50s($ 51- 54) thereby providing a total return of 45% over the 21 month holding period.
There are a couple of important points to add. Firstly, management is willing and likely will pursue a further re-capitalization of the Company once the proceeds associated with the first borrowing have been employed. Thus, DLX is by no means necessarily a 21 month story. Secondly, DLX has essentially no ‘sell side’ research coverage which, with apologies for the sarcasm, is always at least a hint of opportunity.
Model:
BASED ON '03(DEC.):
DELUXE CORP. PER: EBITDA 413.7 CASH VALUATION: HISTORIC PER(N12M; '97 - 00):
SYM: DLX HIGH 15.0 $53.10 HIGH 10.0 $67.64 DR 10.00% 9.00% HIGH 15.8 $43.52
2/14/2003 FAIR 12.0 $42.48 FAIR 7.5 $49.95 FV $58.09 $65.55 AVG. 12.2 $33.61
$38.00 LOW 10.0 $35.40 LOW 6.0 $39.33 DTFV(@20%) $46.47 $52.44 LOW 7.1 $19.56
CURRENT 10.7 $38.00 CURRENT 5.8 $38.00 FCF/EV 5.84%
2004 2003 2002 2001 2000 1999 2003 2002 2001 2000 1999
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
REVENUE 1309.8 1296.8 1284.0 1278.0 1262.7 1363.8 100.0% 100.0% 100.0% 100.0% 100.0%
COGS 444.6 440.2 435.8 453.8 453.0 557.8 33.9% 33.9% 35.5% 35.9% 40.9%
GROSS MARGIN 865.2 856.7 848.2 824.2 809.7 806.0 66.1% 66.1% 64.5% 64.1% 59.1%
SG&A 513.1 508.0 503.0 514.0 518.2 506.5 39.2% 39.2% 40.2% 41.0% 37.1%
39.2% 39.2% 39.2% 40.2% 41.0% 37.1%
D&A 65.0 65.0 73.8 73.8 68.5 61.0 5.0% 5.7% 5.8% 5.4% 4.5%
OTHER 0.0 0.0 0.0 0.0 0.0 0.0
OPERATING INCOME 352.1 348.7 345.2 310.2 291.5 299.5 26.9% 26.9% 24.3% 23.1% 22.0%
0.0% 0.0% 0.0% 0.0% 0.0%
INTEREST EXPENSE 15.0 15.0 5.1 5.6 11.4 8.6 1.2% 0.4% 0.4% 0.9% 0.6%
INTEREST INCOME 0.0 0.0 0.0 2.4 4.8 7.2
PRE -TAX 337.1 333.7 340.1 307.0 284.8 298.1 25.7% 26.5% 24.0% 22.6% 21.9%
TAX -128.1 -126.8 -129.2 -116.7 -108.2 -113.3 -38.0% -38.0% -38.0% -38.0% -38.0%
MINORITY INTEREST 0.0 0.0 0.0 0.0 0.0 0.0 0.0% 0.0% 0.0% 0.0% 0.0%
EQUITY/AFFILIATES 0.0 0.0 0.0 0.0 0.0 0.0 0.0% 0.0% 0.0% 0.0% 0.0%
NET(BEFORE EXTRA) 209.0 206.9 210.9 190.3 176.6 184.8 16.0% 16.4% 14.9% 14.0% 13.6%
EXTRA ITEMS
NET 209.0 206.9 210.9 190.3 176.6 184.8 16.0% 16.4% 14.9% 14.0% 13.6%
PREFERRED
AVAIL. TO COMMON 209.0 206.9 210.9 190.3 176.6 184.8 16.0% 16.4% 14.9% 14.0% 13.6%
E.P.S. $3.99 $3.54 $3.31 $2.75 $2.44 $2.41
SHARES OUT. 52.4 58.4 63.7 69.1 72.4 76.7
CASH FLOW: CAPITALIZATION (DEC '02):
CASH 125.00
NET 209.0 206.9 210.9 190.3 176.6 184.8 ST DEBT 1.60
D&A 65.0 65.0 73.8 73.8 68.5 61.0 LT DEBT 307.00
CHG. OP. A&L 0.0 0.0 0.0 0.0 0.0 0.0 SOE 64.30
DIVS. 77.6 86.5 94.3 102.3 107.2 113.5 STOCK Px 38.00
CAPEX 45.0 45.0 45.0 29.0 48.0 77.0 BV 1.01
FCF 151.4 140.4 145.3 132.8 89.9 55.3
FCF/share $2.89 $2.40 $2.28 $1.92 $1.24 $0.72 NDEBT 183.60
EV 2404.3
DIV. $1.48 $1.48 $1.48 $1.48 $1.48 $1.48
DIV.YLD. 3.89%
Assumptions:
Catalyst