VALASSIS COMMUNICATIONS INC VCI
March 30, 2012 - 11:04am EST by
399
2012 2013
Price: 23.00 EPS $2.53 $3.11
Shares Out. (in M): 42 P/E 9.1x 7.4x
Market Cap (in $M): 970 P/FCF 7.6x 6.6x
Net Debt (in $M): 500 EBIT 237 260
TEV ($): 1,470 TEV/EBIT 6.2x 5.7x

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  • Share Repurchase
  • Newspaper
  • High Short Interest

Description

Valassis is a very cheap and out of favor stock with a strong underappreciated core business.  The Company’s traditional businesses of distributing coupons and advertisements through newspapers has been in decline.  However, this has benefited its shared mail product, which is becoming one of the only ways to reach the market with coupons and print advertisements.  There appears to be a fear in the market that this business could be in secular decline as well as the world becomes more digital, however there has been very little success of digital or online coupons for small ticket items, and the internet does not appear well suited to this type of promotion.  The underlying core business generates a return on tangible capital in excess of 25%, and management has committed its substantial free cash flow to an aggressive share repurchase program.  The stock trades at just over 7x current year stated EPS, and has a short interest of nearly 20% of shares outstanding.

 

Shared mail, which was formerly Advo, was acquired in 2007.  This segment produced 60% of companywide revenue and 80% of operating income in 2011, up from 53% and 48% in 2007, respectively.  The Company has done a very good job managing it, bringing operating margins up from 7% in 2007 to 14% in 2011.  One of the primary drivers of this has been the reduction in unused postage, or packages sent out with less than the minimum 3oz weight that must be paid for, from 21% in 2008 to 15% in 2011.  Postage accounts for over 50% of costs in this segment.  Also, VCI’s companywide capex has ranged from $19-$30mn/year since Advo was acquired, less than Advo’s capex by itself of $71mn, $55mn, and $44mn in 2004-2006, respectively.

 

Shared mail has shown steady improvements in revenues coming out of the recession, with tremendous operating leverage and improving pricing.  Revenues grew by 2.2% and 3.3% in 2010 and 2011, respectively, while segment profit grew by 42.3% and 22.4%, respectively.  Revenue per package mailed has steadily risen, at $0.334, $0.337, $0.363, and $0.375 in for the years 2008-2011, respectively.  I expect another low single digit increase in revenues this year with continued operating margin expansion in this high fixed cost business.  Given the revenue growth in this segment coming out of the recession I do not see any evidence of a secular decline in this business, and believe that it benefits from the decline in newspaper circulation as now mail is the only way to get coupons into customers’ hands.

 

The traditional Valassis businesses of free standing inserts (FSI) and neighborhood targeted offerings have declined with the circulation of newspapers.  After winning a lawsuit against its main FSI competitor News Corp for anticompetitive pricing there was some hope that pricing in this space could recover, but as yet there is no evidence of that happening.  FSI profitability declined to $14mn last year from $25mn the year before, partly a result of a high rate of coupon redemption exhausting advertising budgets early.  This segment earned $66mn in 2006.  Neighborhood targeted had its worst year ever with operating profit of $8mn down from $21mn.  In 2010 the Company benefited from image advertising by BP in the wake of the Gulf oil spill.  The good news about these segments is that it doesn’t appear things can get much worse, and they should still generate free cash even in a runoff scenario, while there is a chance they could see a bounce from cyclical improvements.  The Company’s guidance does not assume any recovery in these segments in 2012. 

 

VCI’s other businesses include a growing coupon clearing business NCH and a digital coupon and display business.  Between them they generated $24mn in operating profit last year, and the digital business is still not profitable as they try to build it out.  There may be a future in in-store coupon promotions tied to a smartphone, but it is unlikely digital can replace large numbers of coupons for those who like to clip them.  The high rates of coupon redemption last year helped NCH as shows like Extreme Couponing may have encouraged more people to use them.  If higher redemption rates continue marketers can manage costs by reducing the value of a coupon and tightening restrictions and expiration dates.

 

VCI has a strong balance sheet and is aggressively deploying its free cash flow into repurchasing its cheap stock.  It took on debt to finance the Advo acquisition, but has paid it down with free cash flow and proceeds from the News Corp lawsuit.  It also termed out its debt and has no significant maturities until 2016.  Since debt fell below 2x EBITDA last year, the Company repurchased 8.9mn shares of stock in 2011.  Management’s guidance assumes they use half of their free cash flow in 2012 to repurchase shares.  However, with only $15mn in scheduled debt payments in 2012 and its free cash flow generation likely to be over $150mn I expect the Company to repurchase over 6mn shares this year, around 15% of shares outstanding.

 

My target price assumes the stock trades at 10x cash EPS.  Management uses a cash EPS figure that takes out stock compensation, but mine only adds back the excess of depreciation and amortization over capex.  Since 2007 this excess has ranged from $.40-$.60/share, and on this “owners earnings” basis I expect them to earn over $3.50 in 2012.  Thus I think this stock could trade at $35 this year with upside in future years from the rapid share count shrinkage.

 

Bottom line:  VCI is an extremely cheap stock that has a highly free cash generative core business that is not going away.  Its traditional businesses of FSI and neighborhood targeted are challenged, but there is little remaining downside in them and no expectation in the stock or guidance of future improvement.  The shares are in my opinion a great value at current prices.

Catalyst

Share repurchase, high short interest, improving economy boosting marketing spending, revaluation
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