Over the last couple of weeks, we have been analyzing and evaluating Pitney Bowes Inc (PBI). Pitney Bowes has been a part of the S&P 500 since its 1957 creation and is one of only 87 firms remaining from the original S&P 500. Our first report covered how it has seen its fortunes decline over the last five years due to the weak economy as well as the continued declining demand for postage mail based products and services. We then analyzed its dividend yield and growth as well as its slumping sales, its intangible asset balances, recent restructuring charges and negative credit actions taken by the rating agencies. Our second report covered its capital structure, asset and liability management and its pension plan. In this report, we will cover Pitney Bowes' free cash flow, return on capital and dividend coverage.
Pitney Bowes' operating cash flows peaked at $1.06B in 2007 and have been stagnantly meandering downward since then. To mitigate the negative impact of its declining operating cash flows on its free cash flows, it has steadily reduced its capital expenditures during the period. The company's capital investment spending peaked in 2007 at $829M ($265M for gross CapEx, $30M received from salvaging old assets and $594M in acquisition spending). Gross CapEx bottomed out in 2010 at $120M and total investment spending bottomed out in 2011 at $156M. 2012 CapEx is at similar levels as 2011 CapEx and the company has not executed any acquisitions since 2010. This has helped keep free cash flows from 2008-2011 comparable with 2007 levels even though the company is seeing steady sales declines. The company's operating cash flows in the first 9 months of 2012 were $440M and this was a sharp decline from the $750M achieved in the first 9 months of 2011. This $310M year-over-year decline was due to higher tax payments in 2012, as a result of tax payments related to the sale of leveraged lease assets, the loss of bonus depreciation and higher income tax refunds received in 2011 as well as lower collections of finance and accounts receivables in 2012. Despite the decline in its operating and free cash flows in 2012 versus 2011 levels, the company still generated $311.8M in free cash flows during the first 9 months of 2012.
Source: Morningstar Direct
Over the last twelve months, PBI earned $365M from continuing operations after deducting $18.4M in preferred stock dividends. This excluded a non-recurring tax benefit of $208M relating to its Capital Services business that it sold off in 2006. Because the company has such a highly leveraged capital position in which it had a slight negative book value in 2010 and 2011 as well as only $124.6M in book value as of Q3 2012, we believe that calculating its ROE would not be meaningful for analyzing and evaluating it. Instead, we will focus on its Return on Invested Capital (ROIC). The company had generated $364M in net income as well as $191M in total interest expense during this time period. The company started off the period with essential zero book value and $4.245B in outstanding indebtedness. We see that it earned an after-tax ROIC of 11.27% during this period. PBI's ROIC performed better than we expected although part of the reason why it is able to utilize its high level of financing leverage (97% of its financial capital is debt) is due to the historically low interest rates. We believe that Pitney Bowes's CEO Murray Martin and his executive team should make it a point to send Hanukkah and Christmas cards to Helicopter Ben and his pilots of money printing at the Federal Reserve for keeping interest rates so low because otherwise, the company would have to cut its dividends in order to increase its debt repayments.
Pitney Bowes has earned $364M in net income over the last twelve months and $450M in free cash flows during that time period. The company has paid out about $300M in dividends over the last twelve months and has demurred from repurchasing any additional stock in order to accommodate a $550M debt repayment. While it would have been nice for the company to have repurchased shares at a much lower price that the $36.755/share it has paid throughout its cumulative history, we felt it was the prudent thing to do with the shareholders money. The reason why we felt it was prudent for the company to pay off that maturing debt with cash instead of refinancing it was because the credit rating agencies had already issued negative credit alerts on the company and paying down $550M in maturing debt helped keep its credit rating from going down further.
Source: Pitney Bowes's Q3 2012 10-Q
The company's free cash flow declined by over $310M year-over-year in 2012 versus 2011 levels due to tax payments related to the sale of leveraged lease assets, the loss of bonus depreciation and higher income tax refunds received in 2011 as well as lower collections of finance and accounts receivables in 2012. Assuming that 2013 free cash flows are an average of the $765M in 2011 and the $450M in the last twelve months, this would result in an estimated $600M in free cash flows. This would cover the dividend obligation by a ratio of 2-1 and would assume that there is no fundamental reason for the company to cut the dividend. However that does not guarantee that the dividend will never be cut because dividends are declared at the discretion of the board of directors and are not required for a company in order to survive as a going concern.
In conclusion, although the company is currently generating strong levels of free cash flows, has solid returns on invested capital and dividend coverage, we are only to invest our time in Pitney Bowes through the continual research, analysis and evaluation of the company. Our biggest concern is that the company is a falling knife based on its continuously eroding sales performance. At some point, the company won't be able to find any more costs to cut and it will reach a floor with regards to its capital investment budget. Because it is at such a low price, we believe that investors should be willing to discipline themselves into waiting for a "perfect pitch" with this company rather than swinging away on it.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.