Deluxe Corp ($DLX) — Initiation (1/26/20)

Price: $49 Market Cap: $2bn Valuation: 8x FCF Category: Core

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I’ve followed this name for years and have only owned it as of December 2018 during the end of year selloff. Shares traded in the $60-70 range during 2014-2018 and sold down to the high $30s in late 2018 only to rebound into the $40s today. I still think this is a cheap stock with a good balance sheet and decent prospects that may ultimately get bought out.

Background

Deluxe operates in 3 businesses:

  1. Marketing Solutions and Other (MOS) — The “crown Jewel” and growth engine of the business.
  2. Checks — Secular decline physical check manufacturing (still profitable).
  3. Forms and Accessories — Small business forms and documents (still profitable).

Here’s how the company describes each of those businesses:

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Long-story short: Deluxe has slowly reinvested the cash from declining businesses (checks and forms) into the faster-growing MOS segment. MOS is now on the cusp of overtaking checks/forms in size.

From 2012 to 2018, revenue grew by 5% per year, cash flow grew by $100m, share count dropped by 12% and debt increased by $250m.

A visual helps paint a better picture…

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And another way to see the segment performance over the years…

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All this to say I have been extremely impressed with management’s ability to deploy cash, grow the overall company, return cash to shareholders, and keep a conservative balance sheet all at the same time!

What about the bad?

Keep in mind this is still a stock with over 50% of revenue in decline! A scary thought to some investors. Despite the fears of “secular decline” in checks and sales falling off a cliff, this has been a fairly stable business.

Checks revenue has declined 1% per year from 2011-2018 and another 3.5% through 9 months of 2019.

That leaves a bit of runway to grab a few puffs and reinvest into MOS businesses.

Free cash flow is going to be down in 2020 and 2021

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At a guided ~$200m ($4.75 per share), FCF will drop by nearly $75m! New management arrived in November 2018 and decided the company would need some added capex and opex investment in each of the next 2 years which fully accounts for the fall-off:

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Restructuring charges will hit opex in 2020 and one-time added capex investments (they’ev dubbed it “New Day”) will total $70-80m over 2020-2021 combined.

I think these are the 2 main reasons the stock trades where it does… It gets lumped into a perceived bad/declining business as a whole despite having a solid customer base and growing divisions within it.

Why still own it?

A checklist is helpful for me here:

  1. It’s a cheap stock — Not just relative to the market but relative to itself! Deluxe currently trades at 1.4x EV/sales and 7x P/CFO… the latter being extremely cheap relative to the market at ~15x… historically, Deluxe has traded at 1.9x EV/sales and 9.5x P/CFO which would make it a $60-70 stock today…
  2. New CEO — In November 2018, Deluxe hired Barry McCarthy from First Data… Barry is a sales-oriented CEO looking to jumpstart organic growth
  3. Cash, cash, cash — This business generates a lot of cash and is not highly levered. Within the next 3-4 years, it’s possible they will have generated half the market cap in free cash flow… I’ll be interested to see how that cash gets deployed between acquisitions, shareholder returns, or something else…
  4. Excellent margins — This is a mid-20% EBITDA margin business with mostly recurring revenue
  5. MOS segment — This segment has similarities to other public companies GoDaddy, Endurance International, and Web.com. The latter was recently bought for $2.2bn despite lower revenue, less growth, and lower margins to the Deluxe MOS business. MOS is a bit more holistic with payroll, treasury, billpay, logo, web design, hosting, marketing, etc.
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  1. Achievable 2023 financial targets — Deluxe is aiming for $300m net new revenue from core growth areas for a total of $2.3bn in revenue at low-to-mid 20% EBITDA margin range… call it $530-575m in EBITDA (23-25% margin) which could equate to $300-350m in FCF (before considering any uses of cash generated along the way!)
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  1. Solid customer base to build from — This investor slide caught my eye from a recent presentation… The web hosting would rank the company in the top 10 providers in that service alone… it’s the combination of add-on services to small business owners that fascinates me…
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It’s possible the stock could muddle along while they wade through this heavier investment period in 2020 and 2021 but I’m fine with that. If FCF was stuck at $200m for the next 2 years that would leave them with $400m to deploy over the next 24 months, add another year into the mix and my guess is that cumulative cash totals almost $700m… I like the strategy, I like the core products, and I’m interested to see how cash gets used. Ultimately, I think this is a decent candidate to get acquired by a larger company looking for the customer base and complementary services.

For some added reading, the company’s 10-K has some good coverage on each portion of the business and various trends within those divisions… It all boils up to a trend of solid and growing cash flow…

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