Description

No, it is not a high-flying internet company.  On the contrary, despite its high-tech name Printing.com is a mundane old-economy printing business focused on providing small- and medium-size businesses with business cards, letterhead, and the like.  The company’s unique business model, however, makes Printing.com return on capital and its growth potential anything but mundane.  The valuation is nothing to yawn at either – the stock is selling for just under 4X NFY FCF, sports an 13.3% NFY dividend yield, and has substantial excess cash on the balance sheet.  Here are the details:

 

Printing.com (PDC LN) is the largest short-run on-demand printer in the United Kingdom, and it serves the country’s market through a network of primarily franchised outlets.  The United Kingdom short-run on-demand industry is a large (£1 billion) and highly fragmented market (Top 3 companies account for about 20% of industry sales) populated largely by inefficient mom-and-pop operators. 

 

While virtually all short-run on-demand printers in the United Kingdom produce print in small volumes at their specific locations, PDC prints all the orders at the Company’s central hub and then distributes them to its outlets.  This enables the company to achieve substantial cost savings through aggregation of small orders on large runs.  As a result, PDC can offer end users substantial savings while generating industry-leading margins.  For example, one can buy 1,000 full color letterheads from a PDC store for £104 vs. the average industry price of £257, which amounts to a 57% discount.  At the same time, PDC boasts EBIT margins circa 18% vs. less than 10% for an average short-run on-demand printer.  PDC’s centralized aggregation model would be challenging to replicate, as the outlay of capital required to recreate the Company’s model is fairly large compared to profits that can be achieved within a reasonable time frame.  For example, it took PDC more than a decade and well over £20-25 million to accomplish its current stature in terms of infrastructure, scale, and brand name compared to NFY FCF circa £3.  A potential entrant is likely to encounter quite a bit more inferior economics given the presence of a sizeable and efficient competitor, such as PDC.

 

As PDC’s market share in the United Kingdom is currently well below 10%, the Company is poised to enjoy a fairly long period of sustained growth as it uses its low cost centralized aggregation model and correspondingly low product pricing to expand at the expense of less efficient rivals.  In addition, the company has dipped its toe into several international markets that have similar fragmentation profiles, which should help maintain an above average growth rate for a long time.  Further, PDC is starting to open up its franchised network to third-party partners.  This will involve providers of personalized stationery, such as t-shirts, pens, etc, receiving the right to sell their products through PDC’s franchise network in exchange for a fee.  Those “network access” fees, most of which should drop to the bottom line as they come with minimal incremental expense attached, are likely to have a substantial positive effect on PDC’s margins and profits.  (The United Kingdom personalized stationery market amounts to about £0.4 billion, which suggests that PDC has ample growth potential in this space.  If PDC captures just 1% of the stationary market, the Company should see its profits nearly double from the current levels.)  On top of it, as PDC franchises its distribution, the company’s growth does not require substantial amount of capital for outlet development, which should enable PDC to grow value per share faster than revenues through share buybacks.  It is important to highlight that the Company’s growth is not likely to be significantly impacted by economic slowdowns which are certain to occur from time to time.  On the contrary, during recessionary periods PDC’s low cost producer status should make it an even more attractive choice in the eyes of end users seeking to minimize overhead, thus protecting the Company’s volumes during downturns.

 

While the main benefit of PDC’s centralized aggregation model lies in the rock bottom printing cost, the Company has a number of other important advantages, which, as a group, enhance PDC’s ability to gain market share from competition:

 

i) Brand name and reputation.  By providing consumers with quality products and consistently marketing PDC created a name that stands for quality, on-time delivery, and guaranteed satisfaction.  As product quality and quick turnaround are among the main factors that affect consumer decision as to what printer should be selected, the strong brand name helps to steal business from competition over time.  The structure of the industry, which is dominated by a myriad of frequently unprofessional mom-and-pop shops, makes brand name an even more potent weapon in the competitive battle.

 

ii) Financial condition.  As a result of the unusual profitability of PDC’s centralized aggregation model the Company is able to generate substantial amounts of cash even as it grows rapidly.  At the same time, most short-run printers in the United Kingdom face dismal economics, which puts them in precarious financial position and, consequently, puts them at a competitive disadvantage vs. PDC.

 

As PDC distributes its print products through a franchise network, the Company’s advantages vs. other potential franchisors should also be considered in the overall framework of competitive advantages.  The Company’s advantages on this front are somewhat reminiscent of its advantages with respect to consumer value proposition, and are as follows (in the order of importance):

 

i)  Low cost centralized aggregation model.  This is the most important advantage, as the franchisee gets an opportunity to offer its customer the lowest price on the block while still making a great margin, as the transfer price it receives from the Company is so low.

 

ii) Highly advanced “plug-and-play” IT system.  PDC franchisees enjoy an advanced “plug-and-play” IT system, which enables them to focus on sales and service (the higher value added activities) as opposed to wasting their time on processing, tracking, and back office.

 

iii) Reputation for reliability/quality/guaranteed satisfaction.  This factor makes PDC a highly attractive franchise partner, as it enables the franchisees to be confident about their own reputation in the eyes of the end users.  (It would make little sense for a franchisee to switch to partner up with an unknown back-end partner, as this would put the franchisee’s own reputation at risk.)

 

iv) Marketing and start-up support.  As the largest player in the United Kingdom market, PDC has the necessary resources to offer its franchisees marketing and start-up support, which is instrumental in getting the business off the ground and developing it successfully.

 

PDC has a highly qualified and reputable management team at helm.  The company’s CEO Tony Rafferty started the business from scratch in 1992 at the age of 24 and developed it into the leading and probably the most profitable player in the UK short-run on-demand print market.  Tony has an excellent track record of creating shareholder value through accomplishing industry leadership in production cost and quality.  At age 40 he is still young and should be able to keep going for a long time.  CEO’s compensation is comparable to similarly-sized companies, and is very reasonable in the overall scheme of things if you take into account Tony’s track record of value creation.  The board is very stringent with executive bonuses and none are awarded unless the performance is exceptional.  (For example, no executive received a bonus in the past two years even though the company’s performance has been solid.)  CEO has a 21% stake in the company (£3 mil at £0.30), so that a 20% stock appreciation would exceed his total cash compensation by a factor of 4X; Chairman has a 3.5% stake in the company, and other top executives own just over 2%.  While executives have not been buying shares personally after the recent decline, this is due to the fact that some of them purchased houses within the past year, and also because executive compensation is fairly low in absolute figures making it difficult to commit a meaningful amount to buying shares.  Although management are not buying personally, PDC has a small buyback program which the Company is likely to expand going forward, as no substantial capital spending is expected in the next several years.  In addition, the company adheres to a progressive dividend policy and has historically returned a significant amount of cash to shareholders via dividends.

 

 

VALUATION

 

In PDC’s case valuation is relatively straightforward.  The calculation of the Company’s NFY FCF is presented in the table below:

 

Net income                   £2.2 million

DNA                            £1.6 million*

CAPX                          (£0.5) million*

 

FCF                             £3.3 million

 

(* The substantial difference between DNA and CAPX is due to the fact that PDC recently completed a major expansion program which nearly doubled its production capacity – and caused a spike in DNA.  Given current utilization rates of circa 55% no additional capacity will likely be needed in the next several years, thus keeping a lid on CAPX.)

 

At £0.30 PDC’s market cap net of cash is approximately £13.0 million, resulting in NFY FCF multiple of just under 4X.  In addition, management is committed to a progressive dividend policy, whereby it intends to distribute a significant portion of FCF via dividends as the company grows.  At the moment PDC expects to pay £0.04 per share dividend in the course of the next fiscal year, putting the stock’s forecasted dividend yield at 13.3%.

 

Given PDC’s growth potential, its ability to grow its FCF at a solid clip without having to invest much capital, and management’s shareholder-friendly capital allocation policies it appears that the stock is significantly undervalued at current levels.

Catalyst

- PDC’s continued rapid expansion in the United Kingdom should increase the company’s visibility.
- PDC’s significant and growing dividend yield should attract interest in the shares of the Company.
- Sheer cheapness of the stock that trades at a significant discount to its intrinsic value should serve as a catalyst as well.