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Jonathan Poland
Jonathan Poland
Articles (505)  | Author's Website |

Deluxe Is a Value Trap

Despite trading close to its 52-week low and under 12 times earnings, the stock is still not a buy

August 23, 2018 | About:

Deluxe Corp. (NYSE:DLX) used to be the company that supplied checks to millions across major banking institutions, and that segment still accounts for one-third of its revenue. Future banking clients, however, will write fewer and fewer checks.

This has forced the company to pivot into business services, which places it in the middle of ultra-competitive markets with exactly zero competitive advantages. Deluxe has done a great job turning its former dominance into a future model for survival. Survival, however, does not equal growth and value creation.

The sellers have built a short position close to 11% of the float. Deluxe has no guru investors and the executive management have been selling the stock, including CEO Lee Schram, who has sold over 80,000 shares worth more than $5.5 million. Executives sell for many reasons, one being they believe their stock is overpriced.

In the last decade, Deluxe has done well to financially engineer higher earnings per share and book value figures. Looking just at these numbers, value investors may think the company is worth owning.

2008
Sales: $1.47 billion
Book: $1.04
Earnings per share: $1.97

2013
Sales: $1.56 billion
Book: $10.34
Earnings per share: $3.65

Trailing 12-month
Sales: $1.97 billion
Book: $22.58
Earnings per share: $4.90

After the market crash in 2008 pushed Deluxe’s stock down to single digits, the stock has risen like a phoenix, up over 650%. On one hand, the company has created a sustainable revenue stream. On the other, it now competes in multiple markets where there are virtually zero barriers to entry.

The company gets impressive double-digit returns on equity, assets and invested capital, plus a 12% net profit margin and an even lower tax rate now. If it were to increase the dividend payout to 50% of earnings, that 4% yield would make the stock worth owning. While it’s unlikely Deluxe will see a precipitous rise in value thanks to 4 million small business customers and 5,100 financial institution clients, the stock has extended its run far too long and the services it offers are only going to get cheaper.

The one possible outlier is if it can figure out a way to convert those small business customers into recurring users of some sort - maybe it starts a payment processor considering the financial institution connection. Square (NYSE:SQ) has over 2 million sellers with 39% of merchants processing more than $125,000 a year. From that it generates over $2 billion in sales a year. Yet, while Deluxe is valued in the market at less than $3 billion, Square enjoys a cap that is over 10 times larger. That’s the problem. Deluxe may be too set in its ways to pivot and innovate.

It doesn’t matter that the company looks well positioned for near-term gains thanks to ongoing restructuring efforts and cost controls that should drive margins. It’s operating in a business that is changing fast, going more and more freemium, and one that it’s not equipped to navigate. With so much money sloshing around in the market, some private equity firm may find the cash flow worth paying 12 times earnings for, but while its stock handily outperformed the S&P 500 over the last 10 years, it’s unlikely to do so over the next 10.

Disclosure: I am not long or short DLX. 

About the author:

Jonathan Poland
I spent more than 15 years helping DIY investors earn over 30% a year. Today, I help business leaders take those insights and build better assets. I rarely write about stocks that I own. Thanks for reading. Do your own analysis before investing.

Visit Jonathan Poland's Website


Rating: 3.0/5 (2 votes)

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Comments

bkw82
Bkw82 - 5 months ago    Report SPAM

I am so tired of imposters writing articles on here. You mention value trap, which is a synonymous word with value investing, and then go on to write an article that not once mentions or attempts to explain value using basic arithematic of FCF available to shareholders. Instead, like all imposters, you go on to talk about tired and superficial ratios like ROE and other market price valuation multiples, that in NO WAY, explains any value that an investor could use, in the same way as when a private investor invests in a private busines.

bkw82
Bkw82 - 5 months ago    Report SPAM

Today the company is being sold for $9.44 Bil. (market cap). Company produces $1 Bil. Of FCF comfortably. Let us assume that they can produce $10 Bil. In the next 10 years (certainly cannot be more since revenuen is flat). Long-term debt of $5.5 Bil. that will be paid back, as always, out of FCF. This leaves you with a possible $4 Bil. Of FCF you can claim as a shareholder.

If you were a private investor that buys, let us say, gas stations (which is more predictable than this company) would you pay $9.44 Bil. for a chance to get $4 Bil. back? Granted, a sale of your shares at the end of 10 years would produce more cash, but certainly not enough (once it discounted back to today) to make this a sound ROI opportunity.

Jonathan Poland
Jonathan Poland - 2 months ago    Report SPAM

Yo Bkw82, Hard to call it an imposter when the article was written in August the stock was priced at $60 and when you commented it had dropped $20 (33%). Not hard to do the math on that one.

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