Can This 'Buggy Whip' Company Reinvent Itself?

Discussion in 'Trading news and analysis (syndicated content)' started by StreetAuthority, Mar 14, 2017.

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  1. StreetAuthority

    StreetAuthority Active Member Official Contributor

    Market observers like to refer to companies involved in mature or dying industries as "buggy whip" companies. What is commonly overlooked is that many of these companies, despite their old-fashioned brand image and reliance on dated technology, have been quietly transforming themselves into high-tech, cutting-edge enterprises. And the stocks are usually a bargain.

    One of my favorite names in this situation is Pitney Bowes (NYSE: PBI). I've written extensively about the company in years past but have been out of the stock for quite a while. It's time to get back in.

    Here's why.

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    The stock has given back 35% of its value over the past year. The readjustment has created an extremely cheap forward P/E of 7.6 with an attractive dividend yield of 5.60%. But is the stock a value or a value trap?

    PBI Is Adapting To The Changing Market
    You don't have to convince me that physical mail is a declining business. At the same time it's important to realize that it will still be around in some form or fashion for quite a few years if not decades to come. You can't send a guitar you sold on eBay (Nasdaq: EBAY) via e-mail. Certain legal correspondence must be routinely followed up or supported with physical mail.

    Pitney Bowes will continue to own the postage processing equipment space for quite some time. In addition, there is still money to be made through maintenance and consumable supplies.

    But years ago, the company did see the writing on the wall and decided to embrace the digital future. For the past decade, management has been quietly buying digital commerce and other software-related platforms as well as directing more capital and energy to this side of the business.

    The transformation has paid off, with digital services comprising nearly 25% of the company's annual revenue of $3.4 billion for 2016. Last year also marked the rollout of the Pitney Bowes Commerce Cloud, a comprehensive e-commerce services bundle that compliments other digital products such as customer engagement solutions. Pitney Bowes also offers "internet of things" networking and geolocation software that counts Facebook (Nasdaq: FB) as a major social network customer.

    However, the company does face some challenges. 2016 revenue was down 5% from the prior year. Drilling down, sales were down an average of 8% in its core mail processing and related services business while the transformational digital business gave up 2%. However, the global e-commerce segment did grow by an exciting 8%.

    Despite these headwinds, management executed admirably. The company generated free cash flow of $430 million for the year which was used to pay $141 million in common dividends and buy back $197 million worth of stock. This tells me that the company was able to successfully deliver shareholder value organically.

    With the revenue disappointment, naturally management guided lower for this year with an estimate of $3.35 billion (basically flat). The earnings per share (EPS) forecast is a different story. 2016 EPS came in at 49 cents which was a painful 75.5% miss from 2015's $2.00. 89 cents of the miss were the result of a goodwill impairment charge and the remainder from currency adjustments (largely due to the strong U.S. dollar) and exiting a handful of international markets.

    The picture looks better for 2017. Although the revenue picture looks flat, the EPS forecast calls for $1.74 which would be a year-over-year increase of 255%.

    Another possibility for the future would be to split the company in two, separating the hardware from the software. This has worked wonders for old tech companies such as Xerox (NYSE: XRX) and Hewlett Packard (NYSE: HPQ), both of which spun off their service and cloud operations in to standalone enterprises. This could also unlock shareholder value, depending on the structure.

    Risks To Consider: Pitney Bowes could very well be its own worst enemy. The legacy postage meter business, while a provider of wonderful cashflow, is an albatross around the company's neck. It is imperative that management continue executing successfully toward the goal of digital transformation. So far, there's a strong track record of that. On a macro level, economic slowdown could stymie growth in the digital business and hurt the core mailing business in its mid and small market division. The best defense is the steady, cash-generating enterprise and consumables business on the mailing side. Management has also displayed its keen ability to manage the balance sheet as well.

    Action To Take: It looks like Pitney Bowes has set the bar low enough for this year to facilitate a surprise on the upside. Based on management's credibility, it looks as though the path is cleared for over-performance. Currently the stock trades at around $13.25 with a forward P/E of 7.6 and a 5.60% dividend yield. Hitting the earnings and revenue targets should propel the forward P/E by nearly 30%, resulting in a multiple of just 9.88 (still very cheap). The result would be a 12-month stock price target of $24 or better for a total return of 90%.


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    Street Authority
     
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