Quad Poised To Double In The Near-Term

Sep.18.11 | About: Quad/Graphics, Inc. (QUAD)

I like simple stocks that I can pick off cheap and aren't overly complicated.

Business Description

Quad (NYSE:QUAD) provides print and related services including catalogs, consumer magazines, direct mail and retail inserts, books and directories. Print related services include binding, digital imaging, mailing and distribution. QUAD has a blue chip customer base including many of the top magazines and retailers like SI, Time, Conde Nast, Williams Sonoma, Victoria's Secret.

QUAD acquired World Color Press in July 2010. QG shareholders received 60% and WCP received 40% plus $93M in cash for its common shares and warrants. The acquisition was a good fit for both companies. Management of both companies felt that pre-tax synergies would be at least $225M. The costs to achieve the synergies would be $195M - $240M and take about 24 months.

QUAD is about halfway through this process. As of Q2-11 it has achieved about $120M of the synergies. It has closed 9 of the 10 plants and cut employees from 5,000 to 3,400.

Over the next 12 months it will realize the remaining $100+M of synergies and stop spending the $100+M per year it has taken to realize them.

Print business is a declining business in the long run, but it is not a business that is going away in the next 3-5 years. Furthermore, I believe that QUAD will offset its revenue losses over time with its investments outside the US.

Basic Thesis

QUAD to me is value / deleverage play with a little bit of restructuring in the mix. QUAD is very oversold. It is down over 50% since listing at $48.50 in almost a year. The market is not properly valuing the synergies of the WCP acquisition and is over-penalizing QUAD for its acquisition/friction costs.

QUAD is currently trading at 3.9x LTM EBITDA and 3.2x 1Y Forward. The normalized market for these companies (R.R. Donnelley & Sons [[RRD]] is a good comp currently trading at 5.1x LTM) is around 5-6x. If the market gave QUAD a more reasonable 4.5x 1Y Forward multiple, it would trade at $42. Each additional turn of EV/EBITDA value is worth $20 of stock price appreciation.

QUAD is paying a 4% dividend and generated FCF in the last two quarters of $115M (adjusted to remove friction costs) which if you annualize and give no credit for 4th Q seasonality, is a 25% FCF yield to the equity. If you include estimates for the next two quarters it is well above a 30% FCF yield.

I look at a lot of these levered names as public market financed LBOs. (LBOs generate big equity returns by highly levering a company and using FCF to pay down debt and drive value to the equity.) QUAD is not highly levered (2.3x EBITDA) but is levered enough that a 25-30%% FCF that is going to be used to buy back shares, pay a dividend and reduce debt, will be highly accretive to the equity.

Downside protection

10% of the equity stock buy back was announced last week and will put a floor under the equity.

The recent refinancing, which will save QUAD $18M per year, extends the maturities on its debt to 2016 and 2018. This greatly reduces the risk of being caught in a debt maturity crunch over the next 3 years. Note that many good companies got destroyed in the 2008 downturn not due to business issues but due to being unable to roll their debt.

So let's not overcomplicate this. I see a sub 4x EV/EBITDA company, with 25%+ FCF yield to the equity, no BK/debt roll issues, a 4% dividend, a 10% equity buyback in place and a catalyst in the friction costs/synergies going away/becoming realized. I am a buyer.

Disclosure: I am long QUAD. My average cost is around $20.25. I think that QUAD is a $50 stock in 12 months.