De La Rue DLAR
June 07, 2010 - 11:45am EST by
miser861
2010 2011
Price: 9.38 EPS $0.90 $1.00
Shares Out. (in M): 99 P/E 10.5x 9.5x
Market Cap (in $M): 928 P/FCF 10.5x 9.5x
Net Debt (in $M): -67 EBIT 117 126
TEV ($): 861 TEV/EBIT 7.4x 6.8x

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Description

De La Rue is one of the highest-quality publicly-traded businesses, yet trades at under 11x run-rate earnings, and comes with a free imbedded call option on inflation, and a put option on economic disaster.  I think De La Rue will be worth about £20 per share in 2 years.

 

De La Rue designs and prints banknotes for over 150 central banks globally, basically every currency in the world.  De La Rue has been printing currency since 1860.  Currency printing was 87% of EBIT in FY2010.  The other material segment, at 13% of EBIT, is Security Products, which produces postage stamps, tax stamps, checks, labels to verify the authenticity of high-end consumer products, etc.  The other segments produce negligible earnings.  My report will focus on the currency business.

 

Note that for personal accounts an unsponsored ADR trades under the symbol DELRF, and trades almost $100,000 per day.

 

Is Cash Dead?

Decidedly not, nor is it necessarily losing share to broader money aggregates.  Below is a table of annualized growth rates of M0 and M3 (M2 in the case of the USD) for the past five years (2005-2009).  M0 is banknotes and coins in circulation.  The Total line aggregates M0 and M3, respectively, for those three currencies.

 

            M0       M3

GBP1    5.8%    12.7%

EUR2    10.3%  7.0%

USD3    4.5%    10.4%

Total    6.9%    7.1%

 

1Bank of England

2European Central Bank

3IMF

 

A graph of historical US Dollar M0: http://twitpic.com/1qzofi

 

It's worth noting that in Q1 2009 year-over-year M0 growth was 8.3% in the UK, 14% in the Eurozone, and 10.9% in the U.S., so M0 is clearly still a tool used by central banks to stimulate nominal GDP growth.  M0 growth is even higher in developing economies: 12% in China, 20% in Brazil, and 16% in India in Q1 2010.

 

In terms of degree of certainty, ranking somewhere behind death and before taxes, a growing nominal money supply is probably among the safest bets one can make over any long period of time, but perhaps especially today.  If you're worried the "printing presses" might slip into high gear to help meet outsized government obligations, I'd rather own the company printing the bills and get a 9% (and growing) earnings yield in the meantime, rather than guess what gold will do while paying a 25 bps cost of carry or a premium to NAV.

 

Currency Printing

The outsourced banknote printing industry is dominated by De La Rue and  #2 competitor Giesecke & Devrient (private).  #3 competitor Oberthur (private) has about 10% market share.  So the market is essentially a duopoly. 

 

Technical ability and scale is valuable.  Consider all the amazing security features of modern banknotes, then consider that De La Rue printed 7.8 billion notes in 2010 at a cost of £316 million, or 4 pence (under $.06) per note.  By comparison, Gannett's newsprint costs alone were $.31 per newspaper in 2009.  According to their financial statements, the U.S. Bureau of Engraving & Printing's costs were $.075 per note in 2009, and they produce a technologically inferior product in my opinion.  I don't foresee new entrants bursting onto the scene and quickly acquiring the reputation and technical expertise De La Rue has earned over 150 years, and being able to reproduce the product at competitive costs. 

 

Every year De La Rue's security features become more sophisticated, thus widening the moat between themselves and potential competitors (including less innovative state print works).  State print works are increasingly acknowledging De La Rue's technological superiority and outsourcing their production.  Private share of the global banknote printing industry has grown from 8% to 15% over the last 25 years, and management believes it will grow to 30% long-term.

 

There are obvious scale efficiencies in outsourcing to a provider who prints 150 currencies versus printing one currency in a dedicated facility.  Even the U.S. Treasury cannot compete with De La Rue's lean cost structure - I doubt Samoa can either.  As sovereigns seek to reduce deficits, the trend toward outsourcing might accelerate either through tenders or the privatization of state print works.

 

The Euro Opportunity

The vast majority of Euros are printed by state print works.  In 2012 a portion of production will be tendered to private printers.  Currently De La Rue prints no Euro notes.  6.0 billion Euro banknotes are printed annually, versus De La Rue's 2010 volume of 7.8 billion, so the opportunity could be substantial.  It's not clear however what portion of the printing will be tendered, so the opportunity isn't quantifiable.

 

Management and Capital Allocation

De La Rue's board has a fantastic track record of returning free cash flow to shareholders and staying focused on the core currency business.  The company has a stated policy of paying out 60% of earnings as dividends (5.5% forward dividend yield).  In the second half of FY2009 (ending March 2009), after the sale of a subsidiary for £335 million, the company paid out a special dividend of the entire proceeds, and repurchased 12% of the shares in the very depths of the recession.  In the last five years, this is how cumulative free cash flow has been deployed:

 

FCF from Ops              300

Subsidiary Sales          336

Total Free Cash Flow  636

Dividends                    (647)    102% of FCF

Buybacks                     (161)    25% of FCF

 

Management has deployed 127% of FCF into productive, non-distracting uses.

 

Currently there is only £11 million of net debt.  If De La Rue ended FY2013 with just .5x debt/EBITDA, I believe they could repurchase over £400 million of stock, or 35% of the shares at an average price of £12.50.  Alternatively they will pay out dividends that you could use to purchase more shares (or other stocks) yourself.

 

De La Rue has negative net working capital (payables and prepayments are greater than receivables and inventory), so the company manages the balance sheet intelligently despite having thuggish customers.  The business has £139 million of tangible invested capital (net working capital plus PP&E), and earned £109 million of EBIT in 2010, a 78% pre-tax return on invested capital. 

 

The U.S. Bureau of Engraving & Printing has $423 million of tangible invested capital, and earned $23 million in 2009 (charging Treasury $.078 per note versus De La Rue's $.076 of revenue per note).  It makes no sense to inefficiently duplicate this printing capacity, when we could sell the BEP and fund an hour worth of federal government operations.

 

A Word on the Other Segments

The Security Products segment is somewhat cyclical as some of the products are used for high-end consumer products.  The revenue in this segment is very roughly 50% government, 50% consumer.  Long-term I think this is a moderate-growth business.  Postage stamp volume is flattish, while tax stamp volumes are growing healthily as governments look for new revenue sources.  And maybe high-end consumer product volume grows faster than GDP long-term.

 

The Identity Systems segment recently won a 10-year £400 million contract for UK passports that begins in FY2011.

 

The Cash Processing segment produces banknote handling equipment for central banks.  It's a lumpy business, and a bad one.  Management will outsource production of the machines starting this year, with a goal to bring the segment to breakeven.

 

Model

FYE 3/31

Revenue          2013E  2012E  2011E  2010    2009    2010-2013 CAGR

Currency         476      453      432      411      349      5%

Security           94        89        82        75        70        8%

Identity            80        76        54        32        30        36%

Cash Proc.       62        60        59        57        66        3%

Eliminations    -16       -15       -15       -14       -12

Total                697      664      632      561      503      8%

 

EBIT                 2013E  2012E  2011E  2010    2009    2010-2013 CAGR

Currency         105      100      95        95        83        6%

Security           20        18        17        15        11        10%

Identity            8          7          5          3          2          46%

Cash Process.  0          0          0          -4         0         

Total                133      125      117      109      96        9%

 

I think De La Rue can do £100 million of net income in 2012/2013.  If the company just built cash they'd end that year with £400 million of net cash.  In reality they'll pay the cash out and repurchase stock, perhaps relevering in the process, and hopefully we or they can make that £400 million worth more than £400 million.

 

Net Inc.            100

Multiple          15

EV                    1,500

Net Cash          400

Equity              1,900

Shares             98.9

Stock Price      £19

 

My model makes no assumptions about winning any Euro volume in 2012.  If De La Rue could capture 10% of the Euro volume at prices similar to the existing portfolio, that could generate £45 million of revenue and maybe £10 million of EBIT, or £1.50 per share of value.

Catalyst

 
    sort by    

    Description

    De La Rue is one of the highest-quality publicly-traded businesses, yet trades at under 11x run-rate earnings, and comes with a free imbedded call option on inflation, and a put option on economic disaster.  I think De La Rue will be worth about £20 per share in 2 years.

     

    De La Rue designs and prints banknotes for over 150 central banks globally, basically every currency in the world.  De La Rue has been printing currency since 1860.  Currency printing was 87% of EBIT in FY2010.  The other material segment, at 13% of EBIT, is Security Products, which produces postage stamps, tax stamps, checks, labels to verify the authenticity of high-end consumer products, etc.  The other segments produce negligible earnings.  My report will focus on the currency business.

     

    Note that for personal accounts an unsponsored ADR trades under the symbol DELRF, and trades almost $100,000 per day.

     

    Is Cash Dead?

    Decidedly not, nor is it necessarily losing share to broader money aggregates.  Below is a table of annualized growth rates of M0 and M3 (M2 in the case of the USD) for the past five years (2005-2009).  M0 is banknotes and coins in circulation.  The Total line aggregates M0 and M3, respectively, for those three currencies.

     

                M0       M3

    GBP1    5.8%    12.7%

    EUR2    10.3%  7.0%

    USD3    4.5%    10.4%

    Total    6.9%    7.1%

     

    1Bank of England

    2European Central Bank

    3IMF

     

    A graph of historical US Dollar M0: http://twitpic.com/1qzofi

     

    It's worth noting that in Q1 2009 year-over-year M0 growth was 8.3% in the UK, 14% in the Eurozone, and 10.9% in the U.S., so M0 is clearly still a tool used by central banks to stimulate nominal GDP growth.  M0 growth is even higher in developing economies: 12% in China, 20% in Brazil, and 16% in India in Q1 2010.

     

    In terms of degree of certainty, ranking somewhere behind death and before taxes, a growing nominal money supply is probably among the safest bets one can make over any long period of time, but perhaps especially today.  If you're worried the "printing presses" might slip into high gear to help meet outsized government obligations, I'd rather own the company printing the bills and get a 9% (and growing) earnings yield in the meantime, rather than guess what gold will do while paying a 25 bps cost of carry or a premium to NAV.

     

    Currency Printing

    The outsourced banknote printing industry is dominated by De La Rue and  #2 competitor Giesecke & Devrient (private).  #3 competitor Oberthur (private) has about 10% market share.  So the market is essentially a duopoly. 

     

    Technical ability and scale is valuable.  Consider all the amazing security features of modern banknotes, then consider that De La Rue printed 7.8 billion notes in 2010 at a cost of £316 million, or 4 pence (under $.06) per note.  By comparison, Gannett's newsprint costs alone were $.31 per newspaper in 2009.  According to their financial statements, the U.S. Bureau of Engraving & Printing's costs were $.075 per note in 2009, and they produce a technologically inferior product in my opinion.  I don't foresee new entrants bursting onto the scene and quickly acquiring the reputation and technical expertise De La Rue has earned over 150 years, and being able to reproduce the product at competitive costs. 

     

    Every year De La Rue's security features become more sophisticated, thus widening the moat between themselves and potential competitors (including less innovative state print works).  State print works are increasingly acknowledging De La Rue's technological superiority and outsourcing their production.  Private share of the global banknote printing industry has grown from 8% to 15% over the last 25 years, and management believes it will grow to 30% long-term.

     

    There are obvious scale efficiencies in outsourcing to a provider who prints 150 currencies versus printing one currency in a dedicated facility.  Even the U.S. Treasury cannot compete with De La Rue's lean cost structure - I doubt Samoa can either.  As sovereigns seek to reduce deficits, the trend toward outsourcing might accelerate either through tenders or the privatization of state print works.

     

    The Euro Opportunity

    The vast majority of Euros are printed by state print works.  In 2012 a portion of production will be tendered to private printers.  Currently De La Rue prints no Euro notes.  6.0 billion Euro banknotes are printed annually, versus De La Rue's 2010 volume of 7.8 billion, so the opportunity could be substantial.  It's not clear however what portion of the printing will be tendered, so the opportunity isn't quantifiable.

     

    Management and Capital Allocation

    De La Rue's board has a fantastic track record of returning free cash flow to shareholders and staying focused on the core currency business.  The company has a stated policy of paying out 60% of earnings as dividends (5.5% forward dividend yield).  In the second half of FY2009 (ending March 2009), after the sale of a subsidiary for £335 million, the company paid out a special dividend of the entire proceeds, and repurchased 12% of the shares in the very depths of the recession.  In the last five years, this is how cumulative free cash flow has been deployed:

     

    FCF from Ops              300

    Subsidiary Sales          336

    Total Free Cash Flow  636

    Dividends                    (647)    102% of FCF

    Buybacks                     (161)    25% of FCF

     

    Management has deployed 127% of FCF into productive, non-distracting uses.

     

    Currently there is only £11 million of net debt.  If De La Rue ended FY2013 with just .5x debt/EBITDA, I believe they could repurchase over £400 million of stock, or 35% of the shares at an average price of £12.50.  Alternatively they will pay out dividends that you could use to purchase more shares (or other stocks) yourself.

     

    De La Rue has negative net working capital (payables and prepayments are greater than receivables and inventory), so the company manages the balance sheet intelligently despite having thuggish customers.  The business has £139 million of tangible invested capital (net working capital plus PP&E), and earned £109 million of EBIT in 2010, a 78% pre-tax return on invested capital. 

     

    The U.S. Bureau of Engraving & Printing has $423 million of tangible invested capital, and earned $23 million in 2009 (charging Treasury $.078 per note versus De La Rue's $.076 of revenue per note).  It makes no sense to inefficiently duplicate this printing capacity, when we could sell the BEP and fund an hour worth of federal government operations.

     

    A Word on the Other Segments

    The Security Products segment is somewhat cyclical as some of the products are used for high-end consumer products.  The revenue in this segment is very roughly 50% government, 50% consumer.  Long-term I think this is a moderate-growth business.  Postage stamp volume is flattish, while tax stamp volumes are growing healthily as governments look for new revenue sources.  And maybe high-end consumer product volume grows faster than GDP long-term.

     

    The Identity Systems segment recently won a 10-year £400 million contract for UK passports that begins in FY2011.

     

    The Cash Processing segment produces banknote handling equipment for central banks.  It's a lumpy business, and a bad one.  Management will outsource production of the machines starting this year, with a goal to bring the segment to breakeven.

     

    Model

    FYE 3/31

    Revenue          2013E  2012E  2011E  2010    2009    2010-2013 CAGR

    Currency         476      453      432      411      349      5%

    Security           94        89        82        75        70        8%

    Identity            80        76        54        32        30        36%

    Cash Proc.       62        60        59        57        66        3%

    Eliminations    -16       -15       -15       -14       -12

    Total                697      664      632      561      503      8%

     

    EBIT                 2013E  2012E  2011E  2010    2009    2010-2013 CAGR

    Currency         105      100      95        95        83        6%

    Security           20        18        17        15        11        10%

    Identity            8          7          5          3          2          46%

    Cash Process.  0          0          0          -4         0         

    Total                133      125      117      109      96        9%

     

    I think De La Rue can do £100 million of net income in 2012/2013.  If the company just built cash they'd end that year with £400 million of net cash.  In reality they'll pay the cash out and repurchase stock, perhaps relevering in the process, and hopefully we or they can make that £400 million worth more than £400 million.

     

    Net Inc.            100

    Multiple          15

    EV                    1,500

    Net Cash          400

    Equity              1,900

    Shares             98.9

    Stock Price      £19

     

    My model makes no assumptions about winning any Euro volume in 2012.  If De La Rue could capture 10% of the Euro volume at prices similar to the existing portfolio, that could generate £45 million of revenue and maybe £10 million of EBIT, or £1.50 per share of value.

    Catalyst

     
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