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Stamps.com is a Fast Growing Small Cap with Fat Margins. But Does it Offer Value?

August 19, 2014 | About:

Fast growing small company – check.
Huge margins – check.
Cash machine – check.
No debt and healthy balance sheet – check.
Interested yet?

I’ll take you through how I analyzed this company and what my conclusion is.

The Retail Shipping Industry

I recently announced that my wife started her own ecommerce business and one of the big hurdles with any online store is shipping.

This isn’t the first time my wife and I tried an ecommerce store.

When we first started and an order came in, my wife would box things up and make a trip to the local USPS, stand in line and mail it out.

As you know, online orders don’t come in at the same time.

Being new to the whole online business thing and just happy to be getting some orders, my wife would make a trip maybe 2 or more times a day.

And if you’ve been to the USPS, you know how frustrating things can get when lines are long and people are slow.

So this was a huge waste of time. It’d literally take 30 minutes to ship out a package.

Funnily enough, this is very common.

With more people making a living off eBay and the Amazon marketplace nowadays, expect the number of packages being shipped to increase.

The Middleman – Stamps.com (STMP)

This is where a middleman service like stamps.com comes into play.

Instead of having to wait in line to buy the postage and ship the box, stamps.com allows you to pay for the postage online.

You then print out the shipping label, stick it on your box and simply drop off your package at the nearest location.

If you have enough volume, you can arrange USPS to come by daily to pick up your boxes.

You get all this by paying a small monthly fee to stamps.com.

Competition

Stamps.com is one of three vendors licensed by the USPS to sell postage. You won’t get more USPS reseller competitors so the obvious competition is really UPS (UPS) and FedEx (FDX).

UPS and FedEx are able to adapt to changes in the environment whereas USPS has to go through congress to make changes.

Both UPS and FedEx welcome new business accounts and it’s also very easy for business owners to go online to pay and print out labels. Once you start gaining some volume with either UPS or FedEx, they will negotiate some good rates for you.

It’s a win-win.

On the other hand, there’s no such thing with USPS. You pay what they charge and it’s not a scalable solution limited to smaller businesses.

Cash Cow Subscription Model

Stamps.com operates a SAAS (Software As A Service) subscription model which means that people pay monthly or yearly for the service.

If the service is valuable and helps people save time and energy it’s a no brainer for people to continue subscribing. By offering a product that helps you respect and maximize your time, it becomes a very sticky business for consumers.

Once a business model like Stamps.com gains traction and hits a certain number of customers to break even, it’s a huge cash cow from there.

Having been in business since the dot com era, Stamps.com is well established.

Just look at the FCF growth that Stamps.com has witnessed.

There is some serious fluctuation, (there’s a reason) but you can’t deny that this small company is a cash cow while trying to grow at the same time.

FCF and Owner Earnings in Millions

FCF and growth have fluctuated wildly over the years, but 2013 looks to be a breakout year with TTM numbers looking good also.

FCF is simply

FCF = Cash from Operations – Capex

Owner Earnings I’m using is;

Owner Earnings =
Reported Earnings (also known as Net Income)
+ Depreciation, Depletion, and Amortization
+ Other Non Cash Charges
– Capital Expenditures (if you can, use maintenance capex)
– Increase / (Decrease) in Working Capital

Using FCF to Perform a Quick Initial Valuation Filter

When I first load STMP into my stock analyzer, I’m greeted with this raw intrinsic value chart based on DCF.

STMP DCF Price to Intrinsic Value – source

Whenever I see a chart like this where the intrinsic value is much higher than the stock price, I immediately know that the company;

a) makes a ton of cash (explained above)

b) has a high growth rate

Checking in on STMP, I’m greeted with both A and B.

However the expected growth rate of 27% that I’m getting is too high for a company that hasn’t proven itself. Not worthy of such a high growth rate at the moment.

Over 5 year and 10 year period, the growth rates aren’t very impressive.

5yr & 10yr FCF Growth Rates

5yr & 10yr FCF Growth Rates

Only comes out to 8.8% over multiple rolling periods in the last 5 years.

It’s 6.2% when you take multiple periods throughout the past 10 years.

These two numbers are indicative of how cash growth has been volatile despite making so much money.

Now if I adjust the growth rate down to next years expected rate of 12%, the chart becomes much more reasonable.

Intrinsic Chart Updated

Intrinsic Chart Updated

So there’s some hope.

But…

NOL’s Good or Bad?

One of the things that worry me about Stamps.com and the true health of the FCF is their NOL and tax credits.

It’s viewed as an asset when a business holds a a large NOL balance with a distant expiration date.

But in Stamps.com case, the NOLs are already expiring.

We have NOL carryforwards of approximately $200 million and $95 million for federal and state income tax purposes, respectively, at December 31, 2013 which can be carried forward to offset future taxable income. We have available tax credit carryforwards of approximately $4.0 million and $3.5 million for federal and state income tax purposes, respectively at December 31, 2013, which can be carried forward to offset future taxable liabilities. Our federal NOLs will begin to expire in 2020, and our state NOLs have begun to expire. The federal tax credits begin to expire in 2018. Under California law, California tax credits do not have an expiration date. –source

If the NOL was set to expire in 2020 like the federal NOLs, then this could be viewed as an asset.

However, in a few years, the NOLs will all be gone and Stamps.com will likely pay taxes in the 33% range.

That’s obviously going to affect the bottom line and drag down performance.

ShipStation Acquisition and the New Direction

At this moment in time, Stamps.com isn’t a bad stock.

In fact, there are some things going for it.

Their recent acquisition of ShipStation.com for $50m in cash was great.

ShipStation is an online shipping software solution to help manage online orders. They let users connect to stamps.com, UPS, FedEx and other carriers.

They also support Amazon Fulfillment so that ecommerce sellers can use Amazon’s fulfillment service.

Not only that, they are the #1 shipping and order management solution for ecommerce stores. Mostly all big ecommerce systems connect directly to ShipStation which is a huge benefit.

My wife uses ShipStation and it’s a life saver. It streamlines and improves the efficiency of shipping packages with other stats to help you see how your business is doing.

It’s finally a step forward for Stamps.com to diversify revenue away from USPS.

I bring this up because…

USPS Risk is Real

I’m sure you’re aware of the financial stuggles that USPS is facing. It’s weird how USPS is government owned, yet they don’t get the funding. They have to act like a privatized government entity which is an immediate disadvantage.

No immediate funding, big pension liability they have to fulfill, slow and cumbersome organization.

What’s worse, USPS will continue to lose out on competition because it can’t make changes on it’s own. Important changes have to go through congress which is a waste of time.

With this additional context, let’s move onto the valuation to see what comes up.

Valuation Today

The expiring NOLs make things slightly more complicated, and the following two points make DCF a problem.

  • Paying taxes will affect the FCF
  • DCF isn’t good for inconsistent FCF companies

It’s easier and cleaner to apply

EBIT Valuation

To get the full explanation of how this works, view this article that takes you through the EBIT process.

Here’s the model for stamps.com

EBIT Valuation Model

EBIT Valuation Model

The main thing here is that I’m using a lower than expected revenue number to start with and using an EBIT multiple ranging from 12x on the conservative side to 20x on the aggressive end.

This gives an intrinsic range of $21 to $34.

The EBIT valuation is showing that STMP is fairly valued to overvalued.

Katsenelson PE Valuation

Rather than go over every detail of how this method works, be sure to visit the full Absolute PE tutorial.

With a current PE of 11.6, the expected growth rate for this PE is 7% based on the table below.

The PE to Growth Rate Conversion Table

The PE to Growth Rate Conversion Table

Stamps.com doesn’t give any dividends so it’s a simple calculation from here.

These are the scores I’m giving Stamps.com.

  • Business safety: 10/20
  • Financial Safety: 20/20
  • Earnings Safety: 13/20

Inputs and the Fair Value Estimate

And these are the calculations based on the above inputs.

Fair Value Calculation

To sum up the method briefly, you start with the current PE and then apply some adjustments based on the strength of the business.

Doing this, the fair value PE comes out to be 13.15 which is equivalent to $37 based on the current EPS.

$37 is at the top of the EBIT range so at this point, I’m inclined to think that the fair value of STMP is currently close to its trading price.

Dig Deeper?

At this point, no.

With the 20% of the work I’ve done here, it gives a pretty good picture for 80% of the business. But that’s because Stamps.com is a business and industry that I am familiar with.

To go deeper, you could dive into customer reviews, average revenue per customers, churn rates, conversion rates and other SAAS metrics.

Despite the initial good looks, considering the risks, inconsistency of Stamps.com and lack of valuation, it’s a pass right now.

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


Rating: 4.7/5 (3 votes)

Voters:

Comments

Bodgeit
Bodgeit premium member - 3 months ago

I have had an eccomerce store for 6 years and always thought that Stamps.com had an inferior product. I was surprised to see their strong growth rate and have to atribute it to their extensive advertising relative to other shipping offerings.

However, Shipstation is the the best shipping platform I have seen. So now we need to know the customer churn rate for Stamps. If it is high, I would expect the rate to drop dramatically and lead to long term higher customer retention.

Strong advertising and high customer retention would be a great combination.

USPS is the best option for most small businesses shipping items in the 1 to 2 pound range. USPS is less expensive, faster and more reliable than UPS in my experience . In fact, UPS is probably USPS biggest customer. UPS does have better tracking though.

Where would we find more info on customer retention?

Jae Jun
Jae Jun - 3 months ago

That's a tough one because I bet they keep that info internal.

There may be ways to find out based on loose data.

But ShipStation is awesome like you said. Stamps.com should find more companies like that to buy out.

knighttof3
Knighttof3 - 2 months ago

Customer retention data is in the company presentation given on stamps.com website.

http://investor.stamps.com/common/download/download.cfm?companyid=stmp&fileid=435200&filekey=62BE105F-A52E-49B2-8F11-D7A728083355&filename=2014_Company_Presentation.pdf

p.29 - Annual Average Paid Customer Churn Rate

If you believe them, it is 3...4% per annum. But I am not sure what "divided by 3 months" means in that context. I am hoping it means if they lose 1% per quarter then they count that as 4% per year, not 1% per year.

knighttof3
Knighttof3 - 2 months ago

BTW Jae Jun, excellent analysis. Like you, I am giving it a pass until the price/intrinsic value comes down a bit.

Bodgeit
Bodgeit premium member - 1 month ago

I just searched customer reviews online and it looks like Stamps.com has a big problem with an average rating of 1.5 stars. I think this mainly applies to there first class mailing feature. Apparently they keep charging customers even after they have cancelled. It may mean another Class Action Lawsuit is coming there way.

Does anyone know where to find a breakdown of there revenue of first class customers verse business customers? Higher growth among small businesses would mean more durable earnings.

Bodgeit
Bodgeit premium member - 3 days ago

Boy we were wrong!

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