Acco Brands (ABD) represents a compelling investment with the potential to more than double in the next two years.   We think murky 4Q06 results have given investors a second opportunity to invest in a predictable, high cash flow business going through a straightforward, researchable turnaround with highly favorable risk/reward dynamics and the added comfort of a high-caliber, high-batting average management team.

 

We view most of the risk in the thesis to an eroding top line.  Our conversations with management and industry participants provide comfort in the ability to improve the cost structure and hit margin goals.  Even if we lose more sales than expected in the office products and computer products line leading to sales of 1.6B sales in 2008, or down 18% from 2006, and achieve a paltry 8% EBIT margin, the FCF yield is 7% and a $22 stock price on 12x FCF.  We think this is very unlikely to happen.  The more likely scenario is management comes within a reasonable range, or exceeds their stated guidance and continues to guide investors on longer term goals.  Assuming 2B in sales, and an 11% EBIT margin in 2008 the FCF yield is 12% with a $36 dollar stock price at 12x FCF.  In the event the turnaround continues at a strong pace we could even seen investors paying up for the future and applying a 15x multiple, or a $45 stock price.  Longer term, with a 13 to 15% EBIT margin being a reasonable range > 2009 the FCF yield would be 15-18% and a 12x multiple would imply $40 to $50.  Debt to EBITDA @ our expected 2008 target is 2x. 

 

 

 

Year	2008/2009	2008/2009	2008/2009		Longer term	> 2009
Scenario	Poor	Medium	Best		Medium	Best
Sales	1600	2000	2000		2000	2200
D&A	70	70	70		70	70
EBIT   margin	128 8%	220 11%	250 12.5%		260 13%	330 15%
EBITDA	198	290	320		330	400
Interest	-40	-38	-37		-25	-25
Taxes	-26.4	-54.6	-63.9		-70.5	-91.5
CFO	132	197	219		235	284
Cap ex	-33	-33	-33		-33	-33
FCF	99	164	186		202	251
Per Share	$1.82	$3.03	$3.43		$3.71	$4.61
Shares	54.3
Yield @ $25	7%	12%	14%		15%	18%
Stock @ 12x	$21.8	$36.3	$41.1		$44.5	$55.4
Stock @ 15x	$27.24	$45.41	$51.4		$55.6	$69.2

 * FCF pays down debt

 

 

Acco Brands was written as a long investment February 14^th, 2006 by circa129.  Refer to the write-up for more information on the Acco spin-off / merger w/ GBC.  We won’t recite the analysis but would like to highlight key points we value:

 

1)   Rational, effective, high caliber management team focusing on long-term value creation.  Industry participants who can see their recent efforts first hand have commented that they are “amazing” operators.

2)   A history of successful turnarounds / restructurings based on similar common principle of cost rationalization combined with product innovation.  This will be management’s 4^th restructuring. 

3)   GBC was run for cash and under-invested in prior to merger with Acco. 

4)   Excellent risk/reward

 

 

Acco is a branded office products powerhouse with a strong history of brand leadership and innovation.  85% of sales hold #1 or #2 positions and are well recognized including: Swingline, Quartet, Wilson Jones, Kensington, Masterlock, GBC, Rexel.  Products include staplers, binders, folders, visual displays, fastener clips, and computer accessories.

 

In an industry that has undergone rapid and continuing transition to private label, Acco strategy is simple: become the “trade up” label for consumers in categories where it’s most rational for the retailers to have only one supplier.  The strategy has worked, evidenced by Acco’s (combined GBC) ability to keep top line flat to slightly up since 2000, when private label penetration has gone from single digits to low 20s percent for the overall industry.  Even more impressive, we believe specifically for Acco’s categories, there are areas where private label penetration has been more rapid than the industry.  Needless to say, rather than wait idly for the transition, Acco works proactively with their customers to facilitate the shift. 

 

While bears view the business negatively in light of a private label risk, a natural discount to the turnaround plan, and an uncertain European environment, we argue Acco has become a critical and necessary supplier to its customers by offering premium labels that allow the pricing umbrella necessary to push private label.  Competitive advantages exist through scale, recognized brands with a fairly high degree of customer loyalty, and a strong history/relationship with retailers.  By not relying too much on one category, and maintaining strong relationships with its customers, Acco is able to innovate out of categories when returns become less attractive, and history proves this.  We think fear regarding murky Q406 results provide an attractive entry point. Analyst ratings are the following: 1 BUY, 3 HOLD, 2 SELL.

 

- How big of a risk is private label, i.e. is this a stable, declining, or growing business?

- How attainable are the EBIT margins goals?

 

1)       Business is stable to slightly growing

2)       Q406 miss is isolated, explainable, and business is back on track. 

3)       Private label has largely penetrated Acco’s product base, despite headline fears

4)       Restructuring plan / EBIT margin goals are appropriate near term and conservative longer term

5)       Europe is an opportunity, could be single digit grower, not over earning, despite headline fears

 

 

Q4 miss unjustly renewed investor fear of private label, presenting a buying opportunity. 

In mid January ABD announced Q406 results would be lower than expectations (16m EBITDA) as a result of planned pre-buys that did not pan out, Europe behind the restructuring schedule, and weaker results from Dell, a big customer in their Kensington computer products line.  The stock subsequently fell from $27 to $21 over the course of the next two months.  A turnaround that was beginning to show fundamental results / appreciation by the market is now unjustly out of favor.  Note, the stock has rallied in the last week before I could post the write-up but considering the longer term potential the stock is still out of favor.

 

Mgmt. says the miss was mostly the result increasing inventory management during the quarter at their major customers.  We were skeptical at first, as this has been an ongoing trend for a number of years in the industry that we feel should have been anticipated, but our research indicates that this was an isolated event observed by other industry participants who shared soft fourth quarters in the respective categories.  Importantly, Q107 seems to be ahead of sales plan and buyers think purchases from Acco overall are growing not shrinking.  We are embracing the fear in this situation and focusing on the longer term results.

 

 

Private label risk dominates sentiment but ~90% or more of the impact has likely been felt.  The headlines are scary.  Office Depot wants to go from ~20% private label to ~50% by end of 07’.  Staples is currently 17% private label, with goals to increase but no official target.  The verbatim continues at other chains.  Most of the private label penetration has occurred for Acco’s brands.  Walking through a hypothetical 100m in purchasing from Acco by a Staples/Office Depot etc. seems to break down like this according to our conversations with the industry:

 

1. Binders / classification folders – 20m purchasing – p.label near full penetration

2. Kensington – 25m – moves fast enough to naturally avoid p.label.  12 to 24mos product cycles

3. Clips / Fasteners – 5 to 10m – p.label 50% penetrated, should go to 75% penetration. 

4. Swingline / Staplers – 10 to 15m – very strong brand.  ABD safe from p.label.  has exited low end.

5. Tech items / board / visual – 15m – growing market but p.label taking out lower end.

6. Specialty items – 10 to 15m – brands have appeal with customers.  P.label won’t impact ABD. 

7. Day timers – 5m – p.label fully penetrated

9. Other – 5 to 10m – unknown.  Assuming 50% still to go p.label

 

While it’s difficult to draw an average purchase analysis to each customer multiple channels seem to confirm the view that private label penetration has largely occurred in Acco’s categories, despite the scary headlines.    

 

Management has meticulously guided investors to their goal of 11% exit EBIT margins in 2008, with an extra 20m or 1% improvement for 2009.  We view this as round 1 of a longer term opportunity.  Competitors MeadWestvaco and Avery Dennison have between 12% and 19% operating margins, with other players falling in the middle of this range.  Skeptics argue the product lines at competitors are too different to draw comparisons, as Avery Dennison has a high margin labeling business but we walked through specific categories as they relate to Acco with one major competitor and were surprised to learn they had embarked on a similar restructuring strategy 2.5 years prior.  At the time, EBIT margins on comparable office products were 8% vs. being at 11% today for this competitor.  Internally, this competitors thinks he can reach 14 to 16%  margins in the next few years by further removing costs from production, distribution, and overhead.  Comparatively, our contact felt Acco was simply a “less lean beast” a few “years behind [his] company.”  While the upper range of 18 or 19% EBIT margins at some competitors is too high for Acco’s specific categories, it seems reasonable to achieve 15% longer term (> 2009), which would yield north of $4 FCF/share.   

 

a) 40m in merger related synergies that will fall in 07/08.  Apparently, the US business has mostly realized synergies, but is being masked by a behind schedule Europe

b) 30m benefit from price increase in 07’ for office products on old GBC contracts to recover raw material increases.  This number is likely too conservative.  Some business will walk and this is included in the figure

c) in 2009 there an additional 20m of costs to take out of the business that should bring EBIT to 12%.  Mgmt does not offer guidance beyond this point but a discussion with them will show the turnaround won’t stop here. 

 

 

It’s understandable that the market views Europe negatively.  Europe is a complicated beast when it comes to office products.  The market is highly fragmented and each geography behaves somewhat independent.    On the surface, customers are consolidating and market share is shifting from small localized mom & pops, to regional/pan European chains, creating buying leverage and naturally accelerating private label penetration.  We spoke with a number of industry observers who are close the Acco’s restructuring efforts and customer buying decisions and we believe

a)       Europe can be a top line grower, lots of opportunity to take share from weaker competitors

b)       Acco is not over earning in relation to the industry dynamics of today, or tomorrow

c)       Private label seems fairly penetrated, some EU geographies more brand loyal than Westerners

d)       Acco is strategically aligned with players that will be consolidating / growing the industry & less reliant on the players that will be losing share

 

Specifically, we think UK, France, Italy, and Germany represent around 60% of the office product market in Europe and have purposely focused our efforts on these regions.  We don’t bake Eastern Europe into our estimates but the economic improvements taking shape there are likely to be a positive. 

Net view on UK:  Sales likely to stay flat but significant cost improvement to be had.

The positives:

1)       Acco enjoys favorable positioning.  Limited opportunity for customers to gain leverage 

2)       Has transitioned the product mix well, offsetting private label risk, with penetration already high 

3)       New heads of Acco UK highly respected by peers 

4)       Lots of costs to be removed

5)       Kensington has massive potential.  Merchandising has been weak to date

The negatives:

1)       Price harmonization across regional SKUs.  Market was fragmented enough in past to allow 30% price differentials on same lines.  Must move to pan-European pricing going forward.

2)       B2B international players are coming in and trying to be category killers.  Have not made much progress / impact in last few years but effort continues. 

 

Net view: Potential for high single digit top line growth

The positives:

1)       Acco not yet driving product lines well here

2)       Could be a real growth market in 12 to 24 months

3)       Market less consolidated, players remain nimble

4)       Solid team in place for this region

The Negatives:

1)       None discovered

 

Net view:  tough sales and margin market but doing “ok” today.  Best bet is to grow with customers taking on this region.  Anecdotal evidence that operations are going as planned.  Industry observers hopeful they can improve situation. 

 

Net view:

Positives:

1)       Very fragmented market.  

2)       No one player has high market share. 

3)       Not showing signs of consolidation. 

4)       High stable margins, little private label risk

Negatives:

1)       hard to generate meaningful traction

-          Failure to hit turnaround goals

-          Difficult European environment

-          White collar employment slowdown

 

DISCLOSURE:  We and our affiliates are long Acco Brands (ABD), and may long additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of ABD.  This is not a recommendation to buy or sell shares.