Time to Check Out Deluxe and J.H. Harland

 |  Includes: DLX, JH
by: Investopedia Advisor

Investopedia Advisor submits: Today, checks account for 40% of all non-cash payments, down from 60% in 2002, according to Federal Reserve reports. Moreover, check usage is expected to decline 4% annually into the foreseeable future. Based on the current prognostications, companies that manufacture checks or service check-writing businesses should be on a slow death march.

John H. Harland Co. (JH), the world’s second-largest check-printer, reported consolidated sales for the first half of 2006 of $532.9 million, which was a 17.1% increase from the $455.2 million reported for the same period a year earlier; and a consolidated net income of $37.9 million. Sales from the company's printed-products segment were $159 million, a 5.9% increase from $150.1 million reported for the same year-ago period. And the company increased its quarterly dividend 16.7%.

As for the number one check-printer, it needs to try harder. For the second quarter of 2006, Deluxe Corp. (NYSE:DLX) posted a second-quarter loss of $2 million and slashed its dividend by 37.5%. The company is expecting EPS to contract 53.2% to $1.45, while revenue is expected to contract $60 million from $1.71 billion in 2005 to $1.65 billion in 2006. Exacerbating matters, Moody's Investors Service (NYSE:MCO) cut Deluxe’s bond rating to 'junk', saying it "is concerned that the company's overall business risk is increasing as the ongoing shift toward electronic payments and forms processing creates price, volume and adverse product mix pressure on the company's mature print-based product lines."

Neither Harland nor Deluxe is receiving much adoration on Wall Street these days: Harland is trading at a 17% discount to its 52-week high, while deluxe is trading at a 55% discount – lows unseen in nearly two decades.

Investors are tetchy; both companies are in the throes of reinvention. In June 2005, John Harland acquired Liberty Enterprises, a provider of checks, marketing services, card services, and education solutions, for $162 million. In April 2005, it acquired Interleave, a provider of “outsourced and item processing for thrifts and community banks,” for $77 million. Management expects both companies to contribute mightily to future growth.

Meanwhile, Deluxe is focused on building its small-business segment and cutting costs. To that end, the company plans to increase investment in the latter – focusing on refining its business model, improving marketing, evaluating its investment processes – and whacking $150 million in superfluity from costs by 2008.

Harland and Deluxe have a number of balls in the air, to be sure, and many investors are unsure how many are going to fall. Uncertainty, though, creates opportunity. Lost on many investors is the fact both companies have the financial wherewithal to endure a protracted turnaround.

Harland sports gross margins of nearly 50% and operating and net profit margins of 12.91% and 7.25%, respectively, twice the printing-industry norm, and generates copious amounts of cash.
Deluxe is also a prodigious cash generator, generating $31.33 million of net operating cash flow for the latest quarter, a 101% increase over the same quarter a year ago. What’s more, its margins are equally impressive as Harland’s, or better. Deluxe sports a 60% gross margin.

Consider this: DuPont (NYSE:DD) successfully transitioned from gunpowder manufacturer to diversified chemicals giant, ExxonMobil (NYSE:XOM) went from a kerosene distiller to integrated energy powerhouse, Wells Fargo (NYSE:WFC) moved from a stagecoach courier to financial powerhouse, International Business Machines (NYSE:IBM) transitioned from a punch-card processor to integrated information technology provider.

Is it really much of a stretch for Harland and Deluxe to successfully transition from check provider to check provider/financial payments/business services provider?

JH 1-year chart:

DLX 1-year chart:

By Stephen Brown, Contributor - Investopedia Advisor

Full disclosure: At the time of release Stephen Brown owned shares in Deluxe Corp.