Why We Bought
Neopost is well positioned in the oligopolistic postal franking machine industry, being the second largest player globally, and the biggest in Europe.
Its revenue stream is robust with over 60 per cent of it recurring. It also has an excellent client base of 800,000 SMEs globally, across which it can cross-sell its other products and services.
Over the course of 2014, the share price came under pressure as volumes of traditional mail declined globally. Neopost’s Mail Solutions division accounted for approximately 80 per cent of revenue and more than 90 per cent of operating profit. However, they have been diversifying and their new Communications and Shipping Solutions division was growing at a significant rate and appeared to be offsetting the falloff in Mail Solutions.
We bought in Q1, 2015, when the shares were available at approximately 11-12x our conservative view of Sustainable Earnings (SE), and the valuations were exceptional: 9 per cent through-cycle free cash flow and circa 8 per cent yield.
We had conviction that their new division, focussing on digital communication and parcel delivery, had the potential for further significant growth.
Holding Period Profile
The share price has been extremely volatile as the market struggles to value a business that has a shrinking (though very cash generative) core business. This has given us several opportunities to top up our position at attractive prices. Not least: Towards the end of September 2015, the market reacted very negatively to a cut in the dividend from €3.90 to €1.70
This rotation of the shareholder register was painful in the short term, but leaves the business better able to manage cash allocation going forward, making sensible allocations between shareholder returns and investments in the fast-growing communications and shipping solutions businesses
By December 2015, we had made Neopost the second largest stock in the portfolio
In H2, 2017, the share price again weakened following weaker trading in Q3.
Having spoken to management, we are confident that this is a short-term issue (following a re-alignment of sales staff to allow entry into an attractive new target market), and that the company remains well positioned
Neopost is now a 4.3 per cent position, a top 5 holding for the Fund.
Over our holding period (c. 2 years 9 months), the shares have returned c. 30 per cent in free cash flow and 15 per cent in dividends (versus our average purchase price)
Outlook (stock & sector)
Revenues in the franking machine business are expected to continue to shrink (at 4-6 per cent per year) but they can manage this decline by increasing market share in the US and following through with cost controls (which remain ahead of target).
Elsewhere, they continue to see some very reasonable growth, both selling software solutions into the existing mail clients and targeting new markets with logistics solutions. They seem to be on track to meet their medium term aim of a 20 per cent operating margin.
Between the markets they now target, they have headroom to achieve sufficient revenue growth to offset the decline in the mail business over the next 3-5 years.
Valuations continue to be extraordinary:
- They trade at just 7x undemanding FY 2017 projected earnings
- Free Cash flow is even healthier (as the franking machine rental business slowly declines, that gives a release of cash from working capital), and is running at over 15 per cent
- They pay a dividend of 7 per cent comfortably covered by cash flow
Whilst we will continue to see shrinking turnover in the legacy franking machine business, management is pursuing a sensible strategy, and the business remains well positioned in some very attractive, fast growing areas of the market.