Investors continue to disdain Transcontinental Inc. (TSX:TCL.A, Financial) (TSX:TCL.B, Financial) given its legacy. It is perceived to be a leader in the terminally declining print industry, and no one seems to give credit to its growing flexible packaging business, its small but solid media business, or management's capital allocation expertise.
The stock remains cheap with a forward price-earnigns ratio of 8.2, even though Ebitda has grown by ~8% in the last five years. The company produces a lot of free cash flow with a FCF yield of 11% and is paying out a solid dividend of over 4.5% with a five-year growth rate of 6%.
Transcontinental has become a leader in flexible packaging in the United States, Canada and Latin America. It is also still Canada’s largest printer. It has $2.6 billion in annual revenues, close to 8,000 employees and 39 operating facilities. The company has been growing its packaging business and shrinking its printing and media businesses as it focused on future growth numbers.
The company's modus-operandi is to make bolt-on acquisitions in its verticals. The company makes effective use of debt to acquire targets in packaging and niche areas in printing which are growing (such as in-store displays and point of sales displays) and then uses its prodigious cash flow to reduce debt in the following quarters. This can be seen in the chart of the liability and equity sides of the balance sheet below. Transcontinental made a big acquisition in 2018 which quadrupled debt (see purple bars), but by mid-2021, it had already paid off more than half of that debt.
Net indebtedness continues to go down rapidly:
Meanwhile, the company continues to ramp up dividends:
In its fiscal third quarter 2021 report, the company highlighted its focus on creating long-term value for its stakeholders.
Transcontinental reported good performance in the flexible packaging segment despite significant headwinds from higher resin prices, unfavorable exchange rates and lower wage subsidies from the government as pandemic aid programs ended. In its print business, the company reported strong demand for its sustainable products and strong organic growth from the gradual reopening of the economy. It also posted good profitability despite significantly lower wage subsidies. Its three segments continued to perform well, including double-digit growth in Media. Investments in Capex and acquisitions are expected to generate growth in the future.
The following chart shows the company's operating cash flow. My favorite metric here is the orange line representing Core free cash flow (FCF), which is free cash flow without changes to working capital. The company shows that it can generate core FCF of around 300 million Canadian dollars ($241 million) a year. Given the company's market cap is about C$1.72 billion, this is a normalized core FCF yield of over 17%. It's also interesting to note that core FCF has been growing at around 6% per year over the last 10 years. Given the low price to core FCF ratio of around 6 and the growth, the company looks very undervalued.
Valuation
Given the company's erratic earnings profile (see green bar above) and large amortization and depreciation as well as asset impairment charges, I feel that a cash flow valuation measure such as the GuruFocus projected FCF method is an appropriate method to value shares of Transcontinental.
The projected FCF method, which uses 80% of book value plus the present value of six years of normalized FCF, is showing a fair value of approximately C$45 per share. The shares are presently trading below C$20. The projected FCF method looks overly optimistic, and I would discount this valuation. In fact, the Projected FCF method has been over-indexing the stock price consistently for the last decade.
On the other hand, the GuruFocus Value chart shows the stock as significantly overvalued based on historical returns and earnings multiples. I find this overly pessimistic given the robust cash flow and business transformation.
Personally, I would split the difference between these two valuation approaches and put my estimate of value in the high 20's range. This is around where analysts predict the fair value of the stock. In the Stockcalc database, there are six analysts that provide a valuation for Transcontinental. The six analysts have a consensus valuation of C$26.17 for Transcontinental for 2022.
Conclusion
Overall, I think, Transcontinental is a solid pick for my portfolio. It is certainly not a high flier, but it is a solid operator. The company has great cash flow and a decent balance sheet. Management is shareholder friendly, pays out a growing dividend and is a good capital allocator. Most importantly, the stock price has a good margin of safety.
