R.R. Donnelley & Sons (NASDAQ:RRD) is a prominent player in the traditional media and printing services. Established in 1864, the Chicago-headquartered company provides pre-media, logistics and business process outsourcing products worldwide. It recently announced a multi-year, multi-million contract with Office Depot to provide a range of production and related services. The contract is expected to benefit both companies. RRD was able to increase its earnings at a double-digit rate in the last 5 years. However, the stock was a disappointment, and is trading well-below its pre-crises valuation.
As of the time of writing, R.R. Donnelley stock was trading at $13.23 with a 52-week range of $11.25 - $21.34. It has a market cap of $2.5 billion. Trailing twelve month [ttm] P/E ratio is 11.6, and forward P/E ratio is 7.4. P/B, P/S, and P/CF ratios stand at 1.4, 0.3 and 3.6, respectively. Operating margin is 4.4%, and net profit margin is 2.2%. The company has some serious debt issues. Debt/equity ratio is 1.9, but this is still lower than the industry average. R.R. Donnelley offers a nifty yield of 7.8%, fully supported by both its earnings and free cash flow.
R.R. Donnelley has a 3-star rating from Morningstar. Out of 2 analysts covering the company, 1 has a buy, and 1 has an outperform rating. Wall Street has diverse opinions on R.R. Donnelley's future. Average five-year annualized growth forecast estimate is 10%. This is a reasonable estimate, given the double-digit growth rate in the past 5 years.
What is the fair value of R.R. Donnelley given the forecast estimates? We can estimate R.R. Donnelley's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1} /(1+r) + E_{2} /(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5} + Disposal Value
V = E_{0} + E_{0} (1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + â€¦ + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E_{0} = EPS = ($1.18 + $1.74) / 2 = $1.46
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 10%. Book value per share is $9.61. The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E_{0} | $1.46 |
V (t=1) | E_{0} (1+g)/(1+r) | $1.45 |
V (t=2) | E_{0}((1+g)/(1+r))^{2} | $1.43 |
V (t=3) | E_{0}((1+g)/(1+r))^{3} | $1.42 |
V (t=4) | E_{0}((1+g)/(1+r))^{4} | $1.41 |
V (t=5) | E_{0}((1+g)/(1+r))^{5} | $1.40 |
Disposal Value | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $12.69 |
Book Value | BV | $9.61 |
Fair Value Range | Lower Boundary | $21 |
Upper Boundary | $31 | |
Minimum Potential | 60% | |
Maximum Potential | 133% |
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for R.R. Donnelley is between $21 and $31 per share. At a price of $13.23, R.R. Donnelley is undervalued by at least 60%. The stock has up to 133% upside potential.
R.R. Donelley is one of the oldest companies in U.S. history. Within the last 2 centuries, it became a global provider of printing and traditional media solutions. Surely, the online media outlets are expanding their presence in the market at an exponential rate. However, expecting online multi-media technologies to eliminate the traditional printing solutions will be a mistake. As World's premier provider of print and related solutions, RRD is well positioned in the market. It serves over 60000 customers worldwide.
The traditional printing sector is fiercely competitive with razor-thin margins. In such a competitive sector, RRD was able to distinguish itself by focusing on large corporations that outsource printing-related services. The company has been a very stable dividend payer, offering 26 cents per quarter since 2007. Nevertheless, the current yield of 7.86% is higher than the year end yield of 2008. Thus, RRD is priced at near the peak-crises valuations. Insiders must have realized that their stock is pretty cheap, since they initiated several purchases. In September, the director Johnson Thomas has acquired 149,000 shares worth more than $2 million. The current price of $13.23 offers a better deal than what the director paid for.
RRD may not be the cheapest stock in the market, but at single-digit P/FCF and forward P/E valuation, it offers attractive entry points. Based on my FED+ analysis, R.R. Donnelley has at least 60% upside potential, which implies that it is a good company to buy at a good price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.