Deluxe Corporation Stock: Too Much Debt And Financials Are Not Improving (NYSE:DLX)

investment thesis

I was looking into stock screeners and Deluxe Inc. (New York Stock Exchange:DLX) was found to have a FW PE ratio of approximately 6, which is much lower than approximately 16 for TTM PE. Examine a company’s financial health to determine whether now is a good time to invest in the company. The debt is a bit too high for me and the financials are trending down, so I’ll hold off on rating the company until I see improvement.

Company Profile

Deluxe Corporation provides solutions to corporations, small businesses, and financial institutions in the United States and abroad. The company offers treasure services, receivables management, fraud and security devices, marketing solutions, and many other services in four reportable segments: payments, data solutions, promotional solutions, and checking.

finance

As of 2nd quarter 2023, the company had cash of $39 million against long-term debt of $1.58 billion. Usually this isn’t much of a concern. However, for a small company like DLX, which has a market capitalization of $850 million, this seems like a significant amount. I generally have no problem with companies acquiring debt to finance their operations, as long as management uses that debt wisely. This means that the company can easily cover the interest expense on its debt. His past interest coverage ratio was much better than in 2022, which was about 2x. Now, many people say 2x his is a healthy ratio, but I typically look for a company’s ability to cover its interest expense on debt of around 5x or more. This means that EBIT is 5 times his interest expense. As of Q2 2023, this ratio is even lower than the healthy baseline of 2x, at around 1.4x. This is a bit alarming and something to consider when determining your company’s margin of safety.

Over the past five years, we can see that the company’s business has deteriorated, with years of declining revenue and years of increasing operating expenses. That’s not the trend I want. I wouldn’t be surprised if things get even worse in FY23.

The company is not on the verge of bankruptcy, but I’m a little worried if things don’t improve.

The company’s current ratio has also been at the lower end of the level that I look for in a company. In recent years, this ratio has been below 1. This indicates that if difficulties arise, the company may not be able to meet all of its short-term obligations. There was no improvement in this ratio in Q2 2023, which is not good for the company, and there was no improvement in its operations.

In the future, companies may not be able to repay short-term debts and liquidity problems may arise, but only time will tell. I’m looking for companies that can achieve a current ratio of at least 1.5, ideally 2.0. This is because we believe this is an efficient current ratio. A balance between being able to repay ST debt and leveraging assets such as cash to drive the company’s growth.

When it comes to efficiency, the company’s ROA and ROE are also mediocre at best. Although it has improved significantly from FY2019, it appears that the management team is not using the company’s assets very efficiently, and ROE is at the minimum level that we would like it to achieve, which is also not noteworthy. about. My minimum goals are ROA 5% and ROE 10%.

I can see that the company has been losing its competitive edge and moat over the last few years, as the return on invested capital has declined significantly since FY2020, which is also not a long-term trend that I would like to see. Below the minimum ROIC of 10%.

Sales growth has also been quite slow over the past 10 years, but analysts say it has increased slightly in the past two years, with around 0% growth expected in FY23 and no growth in FY24. There’s also no sign that the company will be able to achieve above-average growth in the coming years.

Margins have also deteriorated significantly over the last few years, which is another red flag in my opinion.

Overall, we didn’t find anything to like about the company’s financials and should apply a larger margin of safety to suit its risk/reward profile. Everything seems to be trending down, and that’s not what I want for the long-term outlook for the company. Let’s see how much I’m willing to pay for this company to take the risk.

evaluation

So let’s take a simple and conservative approach to the company’s revenue growth. In my base case, I decided to give him a CAGR of about 3.7% over the next 10 years. This is consistent with growth over the past decade. As an optimistic case, we took a CAGR of 7.5%, accounting for acquisitions, the shift to digitalization of business operations, and other unforeseen forces that help it grow at that pace. In the conservative case, we adopted a CAGR of approximately 1.7%. This way I get a variety of potential outcomes that seem reasonable enough to me. Optimistic might be a little too optimistic, but I’m going to stick with it.

In terms of margins, I think we’re being generous here because we’ve decided to improve our gross margins by about 600 bps, or 6%, and our operating margins by about 300 bps, or 3%, over the next 10 years. I believe that technological advances and cost-cutting measures tend to make companies more efficient over time, ultimately increasing their profits.

Regarding the safety margin, we decided to apply a MoS of 40% because the financial situation is not good at all and there is no prospect of improvement. For me to take a risk, I need to be adequately compensated, and I believe a 40% discount is appropriate. That being said, Deluxe Corporation’s intrinsic value is around $16 per share, meaning the company is trading at a premium to its fair value and his FW P/E ratio of 15. This is very different from the FW P/E ratio of around 6 seen on various websites. Therefore, these sites are considered to use non-GAAP EPS. I choose to stick to GAAP standards and be on the conservative side because the company has a lot of red flags for me.

For a complete analysis, I tried using the same MoS-adjusted numbers as before. Yes, there is a significant difference from the GAAP valuation numbers. You can do whatever you want with this information, but in my opinion, the company’s finances are too risky.

Closing comments

I’d like to see an exit for my PT, but even if that happens, I think it’s too risky for me to start a position here. All the metrics that I think are necessary to determine whether a company is a good investment are trending down, and looking at the most recent quarter, the metrics haven’t improved. Revenue growth is not expected for the next few years, and the company insists on using non-GAAP metrics, which I don’t really like.

In terms of dividends, you can get an amazing yield of 6.13%. Looking at GAAP metrics, the company pays out essentially all of its income in dividends. Dividend growth is also zero, and with debt interest so high, I don’t think the dividend will remain as it is. Rather, management would like to cut dividends, pay down debt, and focus solely on improving its financial position. forward.