Transcontinental Inc. (TSX:TCL.A, Financial) (TSX:TCL.B, Financial) (TCLAF, Financial) has been transitioning from a commercial printer (a declining industry as the world digitalizes) to a manufacturer of flexible packaging.
In 2018, the company had taken out over 1.41 billion Canadian dollars ($1.07 billion) in debt to make a major acquisition. However, given the debt and the rapid decline in the company's legacy print business, the market sent shares tumbling. The Covid-19 crisis caused the company to shut down its non-essential print segement, but the essential packaging business (mostly involved in food packaging) continued to operate.
The company has already brought down long-term debt to below CA$1 billion. The low valuation and continued deleveraging should logically restore market confidence over the next two years. I think the stock can double in three to five years while paying a handsome dividend.
Investment thesis
Investors continue to dismiss Transcontinental given its legacy to what is perceived to be a terminally declining print industry. This has driven the stock down to a low valuation, selling for a forward price-earnings ratio below 8 and a free cash yield of 20%. This is not only an overly pessimistic view, however, but also an outdated one. Transcontinental has made major investments in flexible packaging, a modestly growing industry, while continuing to efficiently work on its declining legacy printing business. I judge the stock to have a 50% to 100% upside that can be realized over the medium term. This family-controlled company's management is shareholder friendly and is paying a generous dividend of 5.7%.
The investment
Transcontinental has operations in print, flexible packaging, publishing and digital media. Class A Subordinate Voting shares entitle holders to one vote per share and are listed on the Toronto Stock Exchange; Class B shares entitle holders 20 votes per share and are also listed on the TSX. Both classes of common shares have the same economic rights and the super voting B shares are meant to keep the company under the control of the founding families.
It is controlled by a private company called Capinabel Inc., which in turn is controlled by founder Rémi Marcoux. All of the outstanding shares of Capinabel are held directly and indirectly by Marcoux and members of his immediate family. The shares held by Capinabel represent 71.21% of the voting rights attached to all outstanding shares of the corporation. President and CEO François Olivier is the son-in-law of the founder. Marcoux's daughter, Isabelle Marcoux, is the chairwoman of the board of directors. The Marcoux family has thus far been good stewards of the company, but investors should be aware that in a dire financial situation, the family may put its interests first and that may conflict with that of the minority owners.
Over the last five years, Transcontinental has consolidated the printing industry in Canada and is in the process doing the same for flexible packaging. It divested of its magazines and local newspaper business. In fiscal 2018, it acquired Coveris Americas for $1.32 billion. Transcontinental is now the eighth-largest flexible packaging supplier in North America. It also has a small digital and print media business. The new growth engine of the company is the flexible packaging business since print is declining.
Source: Investor relations presentation – June 2020.
While Transcontinental has taken on approximately CA$1.4 billion in debt for its large acquisition in 2018, it's well supported by cash flow and is rapidly paying down debt.
The company has a good history of leveraging up to make acquisitions and using excess cash flow in subsequent years to bring debt under control. Transcontinental is a strong free-cash flow generator, which should allow for steady deleveraging, periodic dividend hikes and additional acquisition activity down the road.
The company's debt position is summarized below.
Source: Quartely report.
Dividend
The 5.7% dividend yield is well covered with cash flow.
Transcontinental has a long history of dividend payment and growth. It has grown its dividend per share by over 12% annually over the last 20 years. It pays a yield of more than 6%. Compare this to the Canada 10-year government bond yield of greater than 1.00%.
| Dividend Growth annualized | Year | 5 years | 3 Years | 1 Year |
| 6% | 5% | 2% |
Source: Author's calculations.
Growth
The compounded annual growth rate per share over various time periods is provided in the table below. Over the long term, the company has posted good growth numbers. Over the last 20 years, the company grew its Ebitda by 5.13% annually on a per-share basis. The growth has been acquisition-driven.
| Annual rates (per share) | 10 years* | 5 years* | 12 months* |
| Revenue growth(%) | 2.00 | 6.50 | -7.90 |
| Ebitda growth(%) | 12.10 | 10.20 | 14.10 |
| Operating income growth(%) | 3.40 | 2.60 | -8.60 |
| EPS without NRI growth(%) | N/A | 4.90 | 7.60 |
| Free cash flow growth(%) | N/A | 1.70 | 32.90 |
| Book value growth(%) | 3.30 | 13.50 | 3.9 |
Valuation
I have valued Transcontinental using a number of methods. Each of the methods show that the stock is significantly undervalued.
Gordon dividend growth model
Value of stock = D1 / (k - g)
Where:
- D1 = next year's expected annual dividend per share, which is CAD $0.90
- k = the investor's discount rate or required rate of return, which I set to be 5.5%.
- g = the expected dividend growth rate (which I set to be 2%).
As a result: 0.90/(0.055 -0.02) =$25.71
Based on the Gordon dividend discount model, Transcontinental is significantly undervalued with a large margin of safety.
The discounted cash flow model
In regard to the discounted cash flow model, I used a discount rate of 8% and a earnings per share growth rate of 3% for the next 10 years and 2% for the following 10 years. Please note that earnings per share for this company is very variable, so this valuation needs to taken cautiously. If we were to switch earnings to free cash flow, the fair value jumps to around CA$49. While these figures may be imprecise due to the nature of the business, I think it's safe to say that the company is very much undervalued.
Valuation based on historical median price ratios
I used the price-book, price-sales, price-earnings and price-to-operating cash flow ratios to evaluate the stock. It shows significant undervaluation with all these metrics. With the exception of the median price-earnings ratio, all price multiples indicate a fair value in the low to mid-20s.
Industry comparison
With an enterprise value to Ebitda ratio of 4.7, Transcontinental sells significantly below comparable flexible packaging companies in North America. As the packaging business takes on a more dominant role within the company, the gap between the company's EV/Ebitda and the industry average may close.
Transcontinental's operating margins are lower than its flexible packaging competitors. Given high fixed costs, any improvement in operating margins would have an outsized effect on the bottom line due to high operating leverage.
Conclusion
As shown above, Transcontinental is cheap based on traditional value metrics. Its print business is in decline and it's newer packaging business is growing. The challenge for the company going forward will be managing the free cash flow coming out from the print segment well enough so it can de-lever to pay for the debt taken on to acquire the packaging segment, before the former declines terminally. I believe the print business has a good five- to 10-year runway where it can continue to produce free cash flow. The company is on track to pay off $500 million in debt. This goal is possible is realistic since the company is currently generating free cash flow at a run rate of about $250 million and paying out dividends of about $75 million. If the company can reduce its debt to below 2 times (debt/adjusted Ebitda) without cutting its dividend, this will go a long way to restoring confidence in the market.
Disclosure: The author does not own Transcontinental stock but plans to acquire some.
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