Multi-Color Corporation is a good company in a low profile business which has compounded value well over time, but has stumbled recently. We see the stock is a bet on a good management team in a relatively commoditized industry which is consolidating. We see ~35% upside from current levels as management executes and the company digests recent acquisitions.

(Note: We did most of this writeup before the recent move in the stock. The stock is still interesting here, and given its price volatility, you will likely have several more bites at the apple. Also, company has a March yearend).

Multi-Color  has been through a series of stumbles since its acquisition of York Label from Diamond Castle private equity in October 2011:

• Appearance of having paid up significantly for York ($356 million, about 8x trailing EBITDA)
• Problems with Chilean operations post-integration
• Missed sell-side estimates for the last two quarters

We think that most of the concerns are fixable. In a nutshell we see

• A compounder with a history of decent capital allocation
• A capable management team with significant skin in the game
• The ability to buy around management’s cost
• A consolidating industry with the ability to buy targets at accretive prices
• The York deal that should still prove accretive this fiscal year (FY13)
• Earnings “misses” caused by poor sell-side analysis
• A 10%+ FCF yield with upside from deals

Because I love bullet points I’ll throw in a few more here to flag a few issues that may turn people off:

• The industry has relatively low Gross margins – 20% approx.
• The industry has low organic growth – a couple of percent – so you’re relying on a successful rollup
• Relatively short-term visibility into future order patterns
• Customer risk - LABL has 14% of 2012 sales to P&G (next is 4% to Miller)
• Levered balance sheet post-York- managment targets getting back to 3.5x range within a year
• The stock has low trading float, and is pretty volatile
• Private equity overhand from the York deal

Resources:

Limited Sell-side coverage: Hilliard Lyons, AJS, RW Baird (who did a decent initiation earlier this year)

Investor Page: http://www.multicolorcorp.com/investors.html. There doesn’t appear to be a link to their latest presentation, but the CFO is pretty responsive.

Industry and Strategy:

The company is the number two global “label solutions” company (CCL is number one). That is to say, they supply specialty printed labels for the personal and homecare industry (P&G et al), wine and spirit, food and beverage and specialty end markets.

The company tries to differentiate itself through

• moving away from commoditized or low-end label products into more complex and/or technically difficult products in an effort to keep margins up – Pressure Sensitive, In-Mold, Shrink Sleeve, Heat Transfer etc. The details behind these technologies are all in the filings, so I’ll skip them here.
• Offering global solutions to multinational providers
• Focusing on industries such as spirits and wine where margins tend to be slightly higher

The industry is highly fragmented, with CCL having about 3% global market share, and LABL 2%. As with a lot of packaging businesses, there is meaningful operating leverage and value to be obtained from fully loading PP&E. The company has quietly been consolidating in the fragmented high-end consumer products labeling space, with presence in the United States, Europe and Asia.

Management

The current CEO and CFO, Nigel Vinecombe and Sharon Birkett, joined when Multi-Color bought their Australian business (Collotype Labels) in February 2008. One of the interesting aspects of the deal looking back is that the LABL stock price was in the $22 range at the time, meaning that we can buy in around the same price as Mr. Vinecombe. Management have a lot of personal skin in the game (CEO is beneficial owner of 600k shares).

Growth - M&A

Growth has been primarily by acquisition, often small tuck-ins but infrequently larger deals such as York & Collotype:

Date                Name                           Location          Revenues         Price    Focus

Feb 2008         Collotype Labels          Australia          US$130m         $180m Wine and Spirits

July 2010         CentroStampa              Italy                 $50m               $70m   Wine and Spirits, Olive Oil

Oct 2010         Monroe Etiquette        France             $11m               $11m   Wine

Feb 2011         Guangzhou Facility     China               Startup                         Consumer Products

Apr 2011         La Cromografica          Italy                 $11m               $11m   Wine

May 2011        Latin America bus.      Chile/Arg.       n/a                  ~$6m   Wine and Spirits

July 2011         WDH                           Poland             $11m               $9.3m  Consumer Prods and Spirits

Oct 2011         York Label                  US                   $240m             $356m (across all business lines)

Apr 2012         Labelgraphics              Scotland          $20m               $24m   Wine and Spirits

Management has indicated that they intend to continue tucking in opportunistically, primarily small targets and outside North America and have talked about being back in the market for strategic opportunities as early as the second half of FY13.

By our estimates, management has been achieving shareholder returns in the mid-teens and doing a good job of investing retained earnings and cashflows, so we’re happy to have them continue their strategic acquisitions.

York acquisition, subsequent issues

Multicolor bought York Label, their largest domestic peer, from Diamond Castle private equity in October last year at an unusually high price by their standards (just under 8x trailing EBITDA vs. 5-6x for smaller deals). Expected synergies (plant closings etc) reduce the deal multiple and management stated that they expected the deal to be accretive in FY 2013. Despite caution that the deal might cause some short-term dilution, LABL stock sold off in the their third fiscal quarter FY12 when short-term integration costs (particularly in Chilean assets acquired in the deal) led to an earnings miss against analyst estimates.  The US integration work appears to be mostly done and issues in Chile appear to be on the mend as LABL’s existing management teams have right-sized the operation and begun the work of fixing it.

What’s it worth?

Netting everything out, the company has talked about $650m of revenues for FY13, which is around our estimate and we pencil out earnings around $2.15 per share for FY 2013 (ending in March). That puts LABL at about 10.5x this year’s EPS and around 98x FCF vs competitor CCL Industries (TSX: CCL.B) at 13.5x EPS. We see future earnings growth from:

• GDP-level organic growth with operating leverage
• Issues in Chile and startup costs in China get behind them and both operations turn profitable.
• Management targets getting EBITDA margins back to around 18% (from a projected sub 17% for 2013) - comparable to CCL’s 19%. 

We expect value to compound at a mid-teens rate going forward, from a combination of low organic growth and smaller tuck-in acquistions.

Using a 13x P/E multiple, we think shares are worth $27 today and ~$30 a year from now against a current trading price of $21, with further upside if the company continues to allocate its capital intelligently.