(SXP) – Long-Term Boredom, Long-Term Profitability
Abstract
Tracy, the smarter and prettier half of our relationship is the owner-manager of Equity Leadership Collaborative™, a for-profit organization providing consulting, coaching and training based on the Quality of Life Equity Determinants (QoLED). As part of Equity Collaborative’s leadership training, she has developed a personal sentiment card collection named the “Wings That Soar Collection™”. She authors the content, selects the card stock, envelopes, packaging and supervises printing and shipping. She’s a little two-legged, walkin’ around, mini-conglomerate! I wasn’t finding any companies I thought were worth the Boring and Beautiful Money subscriber’s time, so I decided to take a break and walked over to her office. Tracy was seated at her desk finishing a new order she had received by placing cards in envelopes and then putting them into a larger overnight shipping envelope.
Hang with me …
She mentioned she was amazed at how many envelopes it takes to process and fill an order. My inner voice said, “Envelopes are boring!”. I don’t remember the sprint back to my computer, but I do recall my brain being on fire with my new research quest and this is what I found:
Market Cap: $83.04M
Revenue (5-YR CAGR): 9.72%
Operating Income (5-YR CAGR): 17.64%
Earnings from Operations (5-YR CAGR): 37.31%
Levered Free Cash Flow (5-YR CAGR): 23.44%
Dividend Yield: 4.43% (as of 2/12/2024)
CAGR (compound average growth rate)
Still with me? …
The Company
Supremex, Inc., (ticker, (SXP) and pronounced “supreme • X” ), is a 47-year-old leading manufacturer and marketer of envelopes and paper-based packaging products. This LaSalle, Canada, micro-cap, a company with a market capitalization between $50M and $300M, is the only national packaging and envelope supplier in the country. It’s 1,050 employees are spread throughout four Canadian provinces containing eleven manufacturing and print facilities. The firm operates six additional facilities in the United States. The products and services are comprehensive, and the breakdown is as follows:
Envelopes – SXP manufactures a wide range of stock and custom envelopes in an assortment of colors, shapes, and styles. The product line includes, but is not limited to, high frequency envelopes, direct mail, Peel it!, Seal it! envelopes, digital window and photo packaging envelopes.
Packaging – The company provides packaging solutions designed for ease-of-use, they’re low shipping cost efficient, and eco-friendly. Products include e-Commerce, folding and record packaging.
Labels – Labels are pressure-sensitive “flexo” or digitally printed die cut and are deliverable as rolls or sheets based on client preference. Flexo labels are manufactured using the flexography printing method, which produces high-quality labeling and is known for its speed, versatility, and the ability to print on various materials. Tags, Pouches, Cold Foil application, membership cards, and repositionable notes are a few of the firm’s label products.
Commercial Printing - Supremex offers premium commercial printing services catering to their client’s brand visibility and unique identity needs. Services are large format, finishing and packaging and displays.
Envelopes generate 71.9% of the company’s revenue and 29.1% is supplied by Packaging and Specialty Products (labels and commercial printing). The company’s efficient, designed-to-suit manufacturing and distribution provides envelope and packaging solutions to national and multinational corporations, resellers, direct mailers, SMEs (small-to-midsize enterprises), and a variety of government entities. SXP’s competitors are Cenveo (CEVI), WestRock Company (WRK), Tension Envelope, Inc. (privately held), and International Paper (IP).
SXP is a well-run firm with documented growth that pays me while I own it and is a leader in the Consumer Discretionary sector. The sector has a 35.8% year-over-year growth rate, coupled with a trailing 10-year annual sector earnings growth rate of 8.5%. All this makes for excellent cocktail party small talk … but can I buy the company on sale?
Undervalued?
The Discounted Cash Flow (DCF) model is a good starting point to render an intrinsic value approximation. A proxy is sufficient to determine if the current share price is above (overvalued) or below (undervalued) the estimated intrinsic value. The DCF model sums the firm’s future cash flows then discounts them back to the present using a discount rate. The discount rate is the investor rate of return needed to induce investors to justify, or assume, the risk associated with the investment or project. The model produced an intrinsic value of $11.43 per share and, as of this writing, SXP’s share price is $3.16 equating to a 71.36% margin of safety. The margin of safety is a financial concept that represents a financial buffer between the intrinsic or estimated value of a stock and its current selling price. The larger the margin, the better. Value investors build-in this cushion as a hedge against market uncertainties and unforeseen risks. The stock is currently on sale at a 71.36% discount! Very nice but is this the only margin of safety?
Enterprise Value (EV)
The Enterprise Value (EV) is the total value of a firm. It is more comprehensive than market value, (current share price x number of diluted outstanding shares), due to the inclusion of the company’s short and long-term interest-bearing debt, preferred shares, minority interest and cash and cash equivalents. If SXP has a margin of safety relative to its (EV), then the shares are trading below the company’s liquidation value – the residual cash value of the firm if it was sold and all debts were paid, and cash and cash equivalents are added to proceeds cash. Enterprise value per share (EVPS) represents the amount per share you would receive upon liquidation. The firm’s (EV) is $132.12M with diluted outstanding shares of 25,950,000 equating to $5.09 a share. Trading at the current share price of $3.16, (EV) margin of safety is 37.93%. If the firm were liquidated today, you would receive an estimated $1.90 premium for every share you owned.
Old School
You won’t see this used very often and I do not understand why. The Book Value-to-Market Value ratio (BV/MV) is another valuation metric I use to determine if company shares can be obtained at a discount. Book value and shareholders’ equity are calculated the same (total assets – total liabilities) but interpretively not the same. Equity refers to an owner’s interest and a shareholder’s equity ownership. Shareholders’ equity is preferred shares, common stock, paid-in capital and retained earnings, treasury shares (un-retired) and minority interest. Book value is referred to as the firm’s value relative to total assets minus total liabilities. Book value represents the net asset value of the company. Calculated the same, yes, interchangeable, yes-at times, but valuation reference and usage differ. I look for companies whose book value exceeds its market value, hence I am receiving more shareholder value for every $1.00 of share price paid. The book value is $101.65M or $3.92 per share and the firm’s market value is $82.002M at the current share price of $3.16. The (BV/MV) ratio is 1.24 with a margin of safety of 19.33%. The upside is 23.96% and is calculated ($3.16 current share price - $3.92 target price (book value per share) / ($3.16 current share price). For every $1.00 of share price invested (market value), I receive $1.24 of shareholder value (book value) - I’m happy.
We’ve determined Supremex is trading at a discount using three different metrics. Intrinsic value is not an exact number but a range of values. So, we have determined that the company’s true value or intrinsic value is in the range of $3.92 to $11.43 a share, with a margin of safety between 19.33% and 71.36%. SXP is trading at an average discount of 45.34% and yet has attracted only a 3-analyst following. This is where opportunities lie. We’ve identified an unfollowed, undervalued company that so far seems like a potential investment but are we the only ones who feel this way? What about management?
Management
Never eat at any restaurant where the chef will not eat her own cooking. Management that owns a stake in their company illicit a variety of positive externalities. An alignment of interests exists with mutual ownership which can lead to more responsible decision-making. Management share owners tend to have a long-term perspective, increasing the overall company health and sustainability rather than focusing on potentially riskier short-term gains. A management stake signals to investors management’s confidence in the future growth of the firm. With a portion of their wealth tied to the company’s performance, it encourages more risk-averse decisions and tempered business strategies. Accountability is another positive byproduct of management ownership. Management tends to be more attentive to shareholder views and concerns, being shareholders themselves. I like the motivated dedication to perform well from managing teams who invest alongside outside shareholders. They want capital appreciation for themselves and the likelihood all shareholders will share in an increase in value is enhanced. The following officers and directors are company shareholders:
Stewart Emerson, president, CEO, Director – Owns 0.82% of the outstanding shares, 210,000
Murray Rundle, VP, Marketing – Owns 0.16%, 41,388 shares
George Kobrynsky, Director – Owns 0.06%, 16,444 shares
I look for an ownership minimum of 5% and preferably 10% or greater. SXP’s management team collectively owns 1.61% of the firm’s outstanding shares. Lower than my minimum but let’s look at return on assets (ROA), a good indicator of management’s ability to generate profits relative to total assets.
Gross Profit Margin Ratio
Return on assets is calculated by dividing net income by total assets or average total assets can be substituted. I use the Gross Profit Margin ratio to determine management’s profit proficiency use of company assets. For those unfamiliar with this often-overlooked valuation gem, the calculation is (total revenue – cost of goods sold (COGS) / total assets). In 2010, Robert Novy-Marx, a Lori and Alan S. Zelekman Distinguished Professor of Finance at the Simon Business School, University of Rochester wrote an excellent research paper titled "The Other Side of Value: Good Growth and the Gross Profitability Premium”.[1] Novy-Marx stated measuring profitability using gross profits instead of earnings (net income) has the same predictive returns prowess as book value–to-market value, but minus the potential earnings manipulation. I have always said that one year’s metrics tells me nothing and prefer to look at the 10-year historical data. Supremex’s 10-year average gross profit margin ratio is 33.34% return on assets, with a -0.05% CAGR – Outstanding! The compounded growth rate is negative; however, it computes to an average 0.005% decline a year, conversely indicating a 10- year consistent return on assets between 26.66% and 39.31%. Management’s ownership stake is low; however, I like their long-term, efficient asset allocation.
[1] Novy-Marx’s work is very thought-provoking but a word of cation: It is thick with theory, valuation mathematics, financial regression charts and citations. So, if you are not a finance geek in love with metric formulas and theoretical extrapolations then be prepared for your eyes to roll to the back of your head and the taste of solid foods will never be the same.
ROE
When liabilities are deducted from assets, the residual balance is equity – shareholder equity. Return on equity (ROE) measures how effective management is at deploying shareholders’ equity to generate profits. The higher the value, the better because it’s an indicator of the firm’s profit-generating efficiency. (ROE)’s best use is in the comparison with industry and sector averages and a consistently high value illustrates the company can effectively reinvest profits which leads to sustainable long-term growth. Firms that rely heavily on debt will reduce shareholder equity and will affect (ROE). Return on equity will be higher yet the increased leverage (debt) increases the company’s financial risk. Share buybacks, when a firm purchases its shares on the open market, influences (ROE) and I’ll touch on this in a minute. SXP’s return on equity for the last twelve months (LTM) is 18.20%, its 10-year average is 15.55% and its compounded average growth rate over the same period is -2.01%. The firm is considered a consumer cyclical, and the sector average is 104.19%, its Packaging and Container industry average is 50.36%. SXP performs below the sector and industry averages. My benchmark is in the 15% to 20% range for the 10-year average.
Share buybacks can increase (ROE). If a firm uses its cash reserves to buy back outstanding company shares this reduces total assets and shareholder equity, thus (ROE) increases. If the company decides not to use reserve cash but instead uses debt to repurchase the shares then liabilities increase, equity decreases and (ROE) increases. An oscillating combination of these two will have varying influences. The (ROE) calculation is (net income / average total shareholders’ equity) with net income as the numerator and average total shareholders’ equity as the denominator (remember fourth grade?). During the years 2019 to 2022 (fiscal year 2023 is incomplete and is not included), (ROE) rose 40.33%. Why?
The numerator, net income, increased by 56.68% due to a nice rise in total revenue of 10.88%. So, this is the reason for the firm’s impressive (ROE) three-year run? Maybe. During the same period, the denominator, total shareholders’ equity, increased 11.63% due to an 11.63% rise in total assets, outpacing the total liabilities increase of 8.19%. So, what about share repurchases? SXP’s outstanding shares declined by 2.05 million shares or 7.27%. Financial statement analysis, all three statements must be cross-referenced, indicates retained earnings were used to repurchase common shares as this accumulative account fell 10.41% during the three-year period. The cash account rose and fell but of no significance. Interest-bearing debt increased by 1.45%, however, the firm acquired Royal Envelope, Ltd in February 2020, Vista Graphics Communications, LLC. in March 2021, and Niagara Envelope, Inc, in February 2022. This accounts for the interest-bearing debt increase and the corresponding 2.1% increase in the Goodwill account. When a firm repurchases its shares, the transaction is recorded in the Treasury Shares account. If these shares are retired or cancelled the number of outstanding shares is reduced and equity (the denominator) decreases and (ROE) increases. If the firm holds onto the repurchased shares, they are still part of the total shares outstanding and do not have a direct effect on shareholders’ equity. Supremex did retire the treasury shares as evidenced by (1) the decline in the number of outstanding shares and (2) un-retired treasury shares are not recorded on the balance sheet. The increase in revenue, net income, and total assets and the reduction of retained earnings and treasury share retirement contributed to (ROE) growth.
ROIC
Return on Invested Capital (ROIC) is a comprehensive metric that assesses the firm’s profitability and capital allocation efficiency. The calculation is (EBIT[2] x (1 – tax rate) = NOPAT (net operating profit after taxes) / Invested Capital = (total assets – non-interest-bearing current liabilities[3]). I prefer this metric to ROC, return on capital, and ROCI, return on capital invested. ROIC is a holistic metric because it considers the debt and equity – all the capital invested in the business. ROCI does consider debt; however, it does not distinguish between debt and the cost of capital. ROIC includes the after-tax cost of debt providing a comprehensive assessment of the return on all forms of capital. The metric is ideal for comparing companies with different tax structures. ROC and ROCI usually use profit-before-taxes and ROIC accounts for taxes with the use of net operating income after taxes (NOPAT) allowing for on-par company comparisons. I use ROIC because it is less sensitive to capital structure changes over time. It focuses on the return produced by all invested capital, which makes it a more stable performance-evaluating metric. It is less affected by short-term fluctuations and is seen and used as a measurement of a firm’s long-term return capability. Supremex’s current ROIC is 13.38%, with a 10-year average of 11.24% and a 10.38% CAGR. The sector average is -209.59% and the industry average is 10.33%. Supremex outpaces sector and industry averages and throws in a healthy long-term growth rate for free.
[2] EBIT (Earnings before Interest and Taxes)
[3] Non-interest-bearing current liabilities are the amounts of money the firm owes for various short-term obligations. These liabilities do not incur an interest charge. Accounts Payable, accrued liabilities, unearned revenue, and deferred revenue are examples of non-interest-bearing current liabilities.
Accretion
When a firm’s return on invested capital is greater than its cost of capital, the firm is accretive. Accretion implies the company’s operations or investments are adding value to shareholder equity. Operational efficiencies, effective capital allocation and/or prudent investment decisions are the catalysts for such value creation. Cost of capital is the blended cost of debt and equity capital employed by the firm to fund its projects and investments. The cost of debt is the effective interest rate paid on the firm’s borrowings. It is the expense for utilizing debt as a financing source. When ROIC is generating lower returns than cost of capital, the company is said to be dilutive, i.e., decreasing the value of shareholder equity. The company’s 13.38% current ROIC is greater than its cost of capital of 6.59%, meaning operations are accretive.
Debt
SXP’s Total Debt -to -Equity (D/E) ratio is 74.78% and the calculation is (total debt / total equity). The ratio measures the total debt relative to total shareholders’ equity. All interest-bearing debt, short and long-term, capital leases, plus any other liabilities requiring periodic interest payments is considered total debt. Total equity is the shareholder’s ownership interest in the firm and is derived by (total assets – total liabilities). The (D/E) metric is an indicator of the company’s ability to meet its financial obligations based on the amount of leverage employed. A high ratio may signal an increased financial risk precipitated by a heavy reliance on borrowing. A low ratio highlights more equity financing and lower financial risk. Supremex’s ratio seems high but keep in mind that acceptable debt-to-equity levels are company-specific and vary by sector and industry. The sector average is 251.90% and industry average is 499.00%! Supremex fairs well in comparison.
The firm has zero short-term debt, $241,754 current portion of long-term debt and $69,162,816 in long-term debt, September 30, 2023. The debt consists of a $120M revolving credit facility, senior lien secured with a three-year term, maturity in March 2026. The credit line carries an adjustable interest rate tied to either the Canadian or U.S. prime rate, the Secured Overnight Financing Rate (SOFR) or the banker’s acceptance rate plus a 0% to 2.75% margin. As of September 30, 2023, the effective interest rate was 5.86%. An extension was granted in May 2023 and there are no principal payments due until maturity. This equates to an interest-only loan with a balloon payment, the total principal, due March 2026. The company uses the funds for working capital, acquisitions, capital expenditures (CAPEX) and other general corporate purposes. Other general corporate purposes may include dividend payments, debt repayment, legal settlements and share buybacks. Additional smaller interest-bearing term loans and Letters of Credit are:
Four term loans totaling $1,170,660 with a fixed interest rate between 4.23% and 4.69%, maturing between March 2026 and July 2028. A term loan is a lending agreement that may or may not be collateralized and is paid in regular installments with a set maturity date.
Outstanding letters of credit in the amount of $241,000, as of September 30, 2023.
Can SXP meet its interest-bearing debt obligations? I look to the FFO Interest Coverage ratio to determine the answer. FFO stands for “funds from operations” and the ratio calculation is (cash from operations – net cash from discontinued operations / interest expense). My benchmark is a ratio of 2, meaning FFO is twice the interest expense. SXP’s ratio is 6.67 (LTM), with a10-year average of 11.84. I’m satisfied SXP can well cover its debt payments, and, as a backup, has $50,837,184 or 42.36% of unused credit facility if a refinance is needed.
Dividend
If you are familiar with any Boring and Beautiful Money analyses, then you know I like to be paid while owning an asset. Dividend income does just that, however, it is a value to me only if (1) there is long-term payment consistency, (2) there is dividend growth and (3) the dividend must be sustainable. SXP’s 4.43% dividend yield (my benchmark is 3.5% minimum) and payout of 15% (benchmark of 75% maximum) are of no consequence if the previous criteria are not present. Since 2013, the firm has paid a dividend 9 out of 10 years (no distribution in 2022) and the dividend has grown 27.17% YOY, with 18.68%, 14.04% and 15.37%, as 3, 5 and 10-year CAGRs, respectively.
The sustainability indicator is the dividend payout ratio, which is the annual dividend amount divided by earnings (net income). This metric tells an investor what percentage of earnings are distributed to shareholders as dividends. High payouts, say 75% or greater, threaten dividend sustainability and drastically reduces corporate funds necessary for organic expansion. I calculate the payout using levered free cash flow (LFCF) and the equation is (cash from operations – CAPEX – interest paid + (debt issued – debt repaid)). Unlike net income, cash from operations accounts for depreciation and changes in working capital. The current levered free cash flow-based payout is 12.88%, with a 10-year average payout of 73.23%. The company pays a $0.14 annual dividend paid quarterly. The current low share price allows for a significant position build-up and the receipt of an attractive yearly passive income. However, the 10-year average is near the benchmark cutoff and should be monitored going forward.
Conclusion
Supremex, Inc. is a boring envelope and specialty products maker and marketer. It is also a profitable firm with strong long-term revenue and net income growth, a 10-year EPS (earnings per share) CAGR of 5.69%, mature management and well-managed debt. It creates shareholder value through capital appreciation, dividend distribution and share buybacks while producing strong long-term returns on assets, equity and invested capital. The company has achieved this consistent 10-year profit performance during the 9.2-year tenure of its current president and CEO – a major plus! As always, due your own due diligence and determine if the current attributes are sustainable and the temporary challenges are truly temporary.
I do not own shares of Supremex, Inc. (SXP). I will take a position soon.
DISCLAIMER
The above research is not financial advice or a recommendation to buy, sell or exchange any securities or derivatives mentioned. Recluse Media Publishing Group, LLC. as a whole or in part, and/or its officers, staff and/or its assigned, are not liable, and are to be held harmless, in whole or in part for the decisions and/or actions of the reader(s) of this material or the decisions and/or actions of the public, at large. Investors are always encouraged to perform their own due diligence including, but not limited to, seeking professional financial, accounting and/or legal advice prior to making any investment of capital. Investing entails systematic and idiosyncratic risks. Informed investors must be aware of these risks and take them into consideration prior to making any type of capital investment. All rights are reserved by Recluse Media Publishing Group, LLC. This material cannot be copied, duplicated, or reproduced, in whole or in part, without the expressed written consent of Recluse Media Publishing Group, LLC.