Description

Quad/Graphics is a high quality company in a low quality business.  The company is trading at a very low multiple to free cash flow as a result of the secularly challenged industry environment and the company’s decision a few years ago to acquire a much larger competitor.  This resulted in a high level of debt and an awkward transition to the public markets. Recent results suggest that QUAD has achieved a stable level of operating profitability and has meaningfully improved its balance sheet. While there is no immediate catalyst, QUAD's deleveraging presents an attractive return to equity holders in a high quality company with a high quality management, which is likely to be a survivor in this difficult industry segment.

History

Quad/Graphics was founded in 1971 in Pewaukee, Wisconsin by Henry Quadracci.  The company grew steadily until 2010 when QUAD acquired World Color Press, a company that had 1.5 times the revenue of Quad.  As part of the transaction, QUAD become a publicly traded company, issuing Class A shares to the former World Color Press shareholders.  The Quadracci family retains control of the company through its ownership of the super-voting Class B shares.  The family has a 30% economic interest and an 80% voting interest.   An additional 9% of the company is held in an ESOP.  Henry Quadracci’s son Joel, age 47 is the Chairman and CEO of the company.

Business Overview

Quad/Graphics is a leading printer of catalogs, magazines, newspaper inserts and direct mail marketing materials. QUAD operates 162 plants in 17 countries, which allows QUAD to meet the needs of large customers such as Time, and LL Bean.  Having multiple plants closer to the consumer allows direct marketers and magazine publishers to reduce postage costs by mailing closer to the delivery point.  Quad also provides personalization, sorting and other services to add value to its customers, which helps to differentiate QUAD from its smaller competitors.

The printing business faces intense competition for marketing budgets from both traditional electronic media such as TV and radio and newer forms of digital marketing.  In addition, as print’s share of the marketing spending pie has shrunk, competition from other printers has remained fierce. 

Despite these headwinds, QUAD has been able to produce free cash flow in the $250 million to $300 million range for the past several years.  By devoting the majority of FCF to debt reduction, Quad has reduced its debt by approximately $1 billion over the past 6 years.  The company expects to continue to de-lever, allocating approximately 25% of cash flow to dividends, and the balance to debt reduction. 

Quad is positioning itself as a consolidator in the industry.  Quad is a highly efficient operator, with an international presence.  The integration of the World Color Press assets took longer than expected, and required additional resources for deferred maintenance that were not anticipated at the time of the acquisition.  

Quad seems to have put most of these issues behind it.  The company also seems to have learned the investor relations game, beating consensus estimates in the past 6 quarters. 

Capital Allocation

Since the acquisition of World Color Press, Quad has had a balanced approach to capital allocation, with a focus on the reduction of the debt incurred in the acquisition and paying approximately 25% of free cash flow as dividends.  The company has been committed to its $.30 quarterly dividend, even when the stock dropped below $10.  (This is not surprising given the high level of family and employee ownership.)  While management has done a number of small acquisitions over the past few years, they walked away when their bid for Courier Corp. was topped by RR Donnelly.

In the past 6 years, the company has reduced long term debt by approximately $1 billion, and made significant payments to its pension plans.  Unfunded pension liability was $114 million at the end of 2016, compared to $338 million at the end of 2010

Valuation

Despite the increase in QUAD’s price following the release of first quarter earnings., Quad remains very cheap, trading at 5.5 times estimated 2017 EBITDA and at a projected 17% FCF yield.  The company’s estimated 2017 EBITDA of $460 million is about 4% less than 2016.  While the ice cube may be melting, it is melting slowly. 

Catalyst

There is no hard catalyst for Quad. 

This is more of a situation where the stock is likely to improve as the business continues to show solid results and the company continues to de-lever.

RR Donnellly, Quad’s main rival in the printing business recently went through a restructuring which split the company into three pieces.  QUAD may benefit from this, but it is not certain enough to consider a catalyst.