Whenever I hear the term "buggy whip," I think of Homer Simpson's boss, Charles Montgomery Burns, the billionaire character in "The Simpsons" whose quirks lampoon the attitudes of the robber baron class of America's Gilded Age. One of my favorite bits in the cartoon is when some of Mr. Burns' portfolio holdings are mentioned: Amalgamated Spats, Transatlantic Zeppelin, U.S. Hay, and "the up and coming" Baltimore Opera Hat Co. If these had been real companies, then I'm certain they'd be shown the dustbin of history by now.
Of course, buggy whip is used as an analogy for a business that is disrupted, and most likely doomed, due to lack of adaptation and innovation. One of the most recent additions to the dustbin is the once mighty Eastman Kodak (OTCQB: EKDKQ). The company that invented consumer photography failed to surf the digital wave and has now filed for Chapter 11.
Postage meter titan Pitney Bowes (NYSE: PBI), which I profiled last year, always makes the short list. But although the stock price has been beaten like a rented mule and its credit rating has been taken down, I still firmly disagree with the buggy-whip talk. In fact, this is an opportunity for the brave and wise, to pick up a good, transformational stock on the cheap. Let me explain...
Following the leaders…
In the early part of the 21st century, the term "buggy whip" was also associated with two other large, "old tech" companies: IBM (NYSE: IBM) and Xerox (NYSE: XRX). Both of these well-run firms did a great job at anticipating the eventual deterioration of their respective hardware businesses and shifted their focus to high-margin services and outsourcing. IBM has all but disposed of its hardware business while Xerox has become a boss at document management, call-center management and other areas of business outsourcing, as I stated in this article.
Pitney Bowes is following their lead.
Before I tell you how the company is doing just that, let's look at the stock's near-term numbers. The company's most recent earnings report was a mixed bag. First-quarter earnings per share (EPS) increased by 87% to 79 cents, in comparison with the same period last year. That's pretty impressive for a "buggy-whip" maker. Free cash flow was $211 million and the company retired another $150 million in debt, which is not bad either. The company was also able to boost its dividend 1.4%, consistent with its 30-year history of increasing the dividend.
What's spooked the market, though, is the predictable deterioration of the old-fashioned (postage meter and services) core business. First-quarter revenue declined a 7% from $673 million in 2011 to $629 million. This was enough to prompt credit-rating agencies Moody's and Fitch Ratings to cut Pitney's rating from "Baa1/BBB+" to "Baa2/BBB."
Naturally, no one likes credit downgrades. But "Baa2/BBB" is still a decent and stable investment-grade rating. Besides, after the ratings agencies' brilliant performance (sarcasm intended) in awarding garbage-packed, mortgage-backed securities a sterling "AAA" credit rating, I wouldn't lose a lot of sleep over Pitney Bowes' downgrade.
So although Pitney's "old" core business is somewhat challenged now, the "new" tomorrow is very encouraging. As I mentioned earlier, the company is successfully making the transition from "old tech" to "new tech" and it's why I still have a lot of faith in this company..
The future is Facebook...
According to my source at the company, Pitney Bowes has been quietly shifting more and more resources and energy toward Volly, a cloud-based service that helps clients manage their physical and digital mail stream. The most striking feature as described to me is the ability of the Volly platform to deliver all of a customer's electronic bills while allowing these customers to pay all of those bills securely online.
In essence, it's a one-stop shop for receiving and sending mail with a little e-commerce thrown in it. To me -- and this may just be my inner conspiracy theorist trying to get out -- it appears as if Pitney Bowes has figured out how to make money by helping its customers phase out physical mail. It's safe to say that the company understands mail distribution, so it would only make sense that it could figure out e-mail just as well. And that's what smart companies do: adapt well and create demand before the competitors do.
What's more exciting is that Pitney Bowes recently inked a multi-year agreement with Facebook togeocoding and reverse geocoding software, and other location intelligence apps. Translation: When your sister-in-law from Louisiana posts pictures taken at a beachside bar on her Facebook page and it says "Taken near Sandy Bottoms, FL," that's Pitney Bowes' handiwork. This definitely doesn't sound like a buggy-whip business to me.
Risks to Consider: The share price has tumbled more than 40% mainly due to the obvious financial headwinds the company faces: $3.6 billion in long-term debt, ratings downgrades, core business deterioration and a challenging business cycle. Management has done a great job addressing these issues by paying down big chunks of the debt, addressing pension liability funding ($95 million contribution) and devoting the necessary effort into the next-generation products and services.
In addition, corporate insiders have stepped up big time and started to buy the stock. Most significantly on May 21, Chairman of the Board Murray Martin bought 20,000 shares, with Chief Financial Officer Michael Monahan following suit with a 10,000-share purchase. Seeing company insiders buying the stock is always a confidence booster.
Action to Take -- > Pitney Bowes' share price is currently floundering around $13.75, with a forward price to earnings ratio (P/E) of 6.6. This results in a sporty dividend yield of about 11%. But don't get used to it.
I don't see any near-term events that would concern me right now. Free cash flow is respectable and the dividend payout ratio is a comfortable 55%, which isn't bad for a mature business like Pitney.
Look at it this way, even a 50% dividend cut, it would still result in a 5.5%and ownership in a well-run name that is making a successful transition into a niche market. A slight multiple expansion from seven times earnings to nine times earnings would result in a stock price of $19. That's a 38% increase before dividends. The tradeoff, though, is patience. Investors who buy into the stock now may only see the rewards a year or two in the future.