Stamps.com: Another EPS Beat, Is There More Ahead?

| About: Stamps.com Inc. (STMP)

Summary

Recent acquisition positions STMP in rapid growth e-com delivery business.

High cash conversion underscores highly profitable franchise still under-appreciated by Wall Street.

Are more upward revisions in store in 2016?

Rating

Buy

Stamps.com, Inc. (NASDAQ:STMP)

Shareholders of Stamps.com were treated to an upside surprise in the financial report for the quarter ending December 2015, as both sales and earnings topped expectations. Management also delivered guidance for the year 2016 above prevailing estimates. We reiterate our Buy rating on STMP and adjust our target price to $125.00.

52-Week Range

$114.26-$53.91

Long-Term Debt

$161.6 mln.

Shares Outstanding

16.6 mln.

Debt/Equity

67.8%

Insider/Institutional

10%/85%

ROE (LTM)

11.9%

Public Float

15.0mln.

Book Value/Share

$14.39

Market Capitalization

$1.6 bln.

Daily Volume

380,000

Click to enlarge

FYE Dec

FY 2015A

FY 2016E

FY 2017E

EPS ($)

ACTUAL

CURRENT

PREVIOUS

CURRENT

PREVIOUS

Q1 March

($0.06)A

$0.56E

$0.48E

$0.63E

Q2 June

($0.64)A

$0.58E

$0.53E

$0.65E

Q3 Sept.

$0.42A

$0.59E

$0.52E

$0.67E

Q4 Dec.

($0.00)A

$0.83E

$0.58E

$0.93E

Year*

($0.26)A*

$2.56E*

$2.11E**

$2.89E*

P/E Ratio

Neg

37.6x

49.7x

Change

-111.6%

1046.6%

12.9%

Click to enlarge

FYE Dec.

FY 2015A

FY 2016E

FY 2017E

Revenue ($ mil.)

ACTUAL

CURRENT

PREVIOUS

CURRENT

PREVIOUS

Q1 March

$44.1A

$67.4E

$65.4E

$77.5E

Q2 June

$48.4A

$69.4E

$70.4E

$79.8E

Q3 Sept.

$51.7A

$72.2E

$74.2E

$83.0E

Q4 Dec.

$69.9A

$98.1E

$79.9E

$112.8E

Year*

$214.0A

$307.1E

$289.8E

$353.1E

Change

45.3%

43.5%

-

15.0%

-

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*Non-GAAP EPS: $1.57A in FY15, $4.22E in FY16 and $4.39E in FY17

Quarter highlights

The acquired Endicia operation contributed to sales and earnings for six weeks in the quarter ending December 2015, helping drive total sales to $69.9 million. Postage volumes, paid customers and revenue per customer reached record levels as Endicia's high-volume shipping customers were added to the mix.

Company Description

Stamps.com offers online postage solutions to customers in the U.S. In addition to mailing and shipping through the U.S. Postal Service, the company offers multi-carrier shipping services through its ShipStation, ShipWorks and Endicia branded platforms. Stamps.com also provides patented PhotoStamps services that allow customers to create and buy personalized postage. Stamps.com serves a mix of individual, home office, business and large commercial customers that have significant mailing and shipping requirements.

Stamps.com converted an estimated 37% of sales to free operating cash flow in FY15. Management indicated free cash flow from operations near $79 million in FY15. After using $25 million to acquire Endicia and borrowing $165 million, cash and investments totaled $75.2 million at the end of the year. Management's guidance for revenue in FY16 is in a range of $290 million to $310 million, providing between $5.00 to $5.50 in earnings per share, excluding non-cash expenses such as depreciation and amortization and stock compensation. After updating and refining the earnings model, our estimate for sales in FY16 is revised upward to $307.1 million. We expect $4.22 in earnings per share adjusted for non-cash expenses. Our price target has been increased to $125, representing a 30.0 multiple against our revised adjusted earnings estimate of $4.22.

Fourth Quarter 2015 Financial Results

Virtually all metrics for Stamps.com pointed higher in the quarter ending December 2015. Revenue increased 67% compared to the same quarter last year to $69.9 million on increases in postage volumes, paid customers and revenue per customer. Paid customers increased to 633 in the quarter and the monthly average revenue per customer (ARPU) increased to $35.35. Postage printed increased to $1.0 million in the quarter, compared to $613,263 in the same quarter last year. We believe the dramatic increase in ARPU and total printed postage is the result of the company's continued focus on high-volume shippers. The Endicia deal, which is the most recent accomplishment in this strategic plan, brought new customers to the fold, most of which we believe can be described as commercial shippers with high-volume activity.

We believe it was primarily the contribution of the recently acquired Endicia operation that boosted results in the quarter. Endicia contributed to sales and earnings in the last six weeks of the quarter after the deal closed in the third week in November 2015. Unfortunately, management declined to provide details on organic sales or on Endicia sales or profits in the quarter, citing plans to fully integrate Endicia's high volume shipping services into the fold and the intention to avoid a piecemeal approach to evaluating sales. Endicia sales were apparently incorporated into total Services, Products and Custom Postage segments.

Total gross profit margin climbed to 81.1% in 4Q15. We believe economies of scale helped drive efficiencies in the sale of Products and Services. The gross profit margin in the Custom Postage segment declined in the quarter due to a mix shift to high-volume orders for custom postage that commanded lower profit margins. Postage services provided the majority of sales and highest profit margin.

The reported operating loss totaled $71,000 in the quarter. The company makes much of non-GAAP operating results achieved by adjusting operating profits by non-cash expenses. This quarter, the list was lengthy and the amount material, including $8.1 million in stock-based compensation; $1.9 million income tax benefit; $1.5 million in amortization of intangible assets; $20.1 million contingent consideration charges related to the ShipStation acquisition; $500,000 for acquisition-related charges and $11,000 for capitalized debt issuance costs. Altogether, the exclusion of this laundry list of expenses left non-GAAP operating income at $29.1 million. Non-GAAP net income after these adjustments was $28.1 million or $1.57 per share.

Year-End 2015 Financial Results

Fourth quarter financial performance brought total sales for FY15 to $214.0 million, representing a 46.3% increase over the previous year when sales totaled $147.3 million. Besides Endicia, the acquired operations of ShipStation and ShipWorks, with their multi-carrier solutions for shippers, contributed to the dramatic year-over-year increase, after the deals closed in last summer and early fall 2014. The company has not yet published a cash flow statement, but during the earnings conference call, management indicated free cash flow from operations totaled $79 million in the year. The implied sales-to-cash conversion rate was 37% for the year.

Stamps.com balance sheet cuts a new silhouette following the close of the Endicia deal. The company borrowed $165 million to supplement its own cash for the purchase price of $215 million. Stamps.com now has $161.6 million in debt on the balance sheet at the end of December 2015. Cash resources totaled $75.2 million. Working capital declined to $10.6 million compared to $50.3 million just three months earlier.

During the earnings conference call, it was announced that the board of directors had approved a $20 million stock repurchase program. At the current stock price, this represents approximately 207,800 shares or less than one day of trading volume. Neither will the share buyback compensate fully for the approximately 560,000 shares management said will be issued in the coming year related to an acquisition consideration.

Updated Estimates

Reported revenue in the quarter handily topped our estimate for $56.6 million and the consensus estimate for $58.0 million. Likewise, $1.57 per share in earnings adjusted for non-cash expenses was significantly higher than our estimate of $0.87 per share and the consensus estimate of $0.94 per share. The remarkable 'beat' in the quarter might inspire some to ratchet up estimates for the coming quarters. However, the discrepancy between expectations and actual results was more or less a matter of the opacity surrounding Endicia's financial performance and accounting treatments for the acquisition. Stamps.com management had disclosed few details on Stamps.com performance. Even the fourth quarter 2015 financial earnings announcement left questions unanswered. Consequently, we continue to approach estimates for Stamps.com with a conservative view in anticipation of adjusting estimates as quarterly financial reports reveal more about the potential in the combined operation.

During the earnings conference call, management indicated that following the Endicia deal, the combined operation commands as much as 30% of the USPS domestic priority postage sales. Stamps.com now appears to enjoy a commanding position in the postage and shipping market. Management reiterated their plans to optimize advertising, marketing and sales for the combined brand portfolio. The integration process for Endicia has been underway for two months and the company has apparently made progress in unifying marketing activities in one unit and setting up resources and training for direct sales personnel. They continue to express confidence in the potential for synergism among the company's main brands and described the availability of multiple shipping options vital as to capture or retain customers with changing shipping needs.

Concurrent with the earnings report, management outlined guidance for FY16 with sales in a range of $290 million to $310 million and earnings per share of $5.00 to $5.50 adjusted for non-cash expenses. Additional points in management's guidance:

Interest cost in a range of 2% to 3%. More pronounced seasonality with strongest sales activity in the December quarter and the second strongest in the March quarter. Cash taxes near 3%. Capital investment near $5.0 million.

After updating our earnings model to reflect 4Q15 financial results, we made adjustments to our sales estimates to reflect management's guidance for more pronounced seasonality. Now that Endicia's high volume business has been folded into the mix, quarterly sales results will reflect the substantially higher holiday shipping activity in the December quarter. We also adjusted assumptions related to Endicia's contribution to each of the four segments reported by Stamps.com. Otherwise, we left our assumption of 15% year-over-year organic sales growth in place, which reveals our confidence that the company can capture market share during the year. Of course, the primary growth in the year will come from the addition of Endicia sales to the mix. The changes lead to an increase in our sales estimate for FY16 to $307.1 million (from $289.8 million).

Our cost of goods and operating expense assumptions were refined to reflect recent cost and spending patterns. The overall gross margin is now 79.4% (from 79.8%). We also have some concern that management plans to 'optimize and enhance' sales and marketing as well as 'enhance' the company's solutions for high-volume shippers. Management made no mention of an increased operating budget and mentioned efficiencies that could accrue to the combined operations. However, we have some concern that supporting multiple brands and a wide array of customer types from small businesses to large volume shippers could present challenges for sales and marketing strategies. Accordingly, we cross-checked our operating expense assumptions to confirm an adequate increase in budget to support the company's plans for sales, marketing and research and development. Our total operating expense estimate increased to $175.0 million (from $173 million).

The combined result of these minor but numerous changes is an estimate of GAAP earnings per share of $2.56 per share (from $2.11 per share) in FY16. On a non-GAAP basis, after adjusting earnings for non-cash expenses, our estimate for FY16 is $4.22 per share (from $3.84 per share).

Outlook

Management's guidance for FY16 was well above the estimates we had in place for adjusted earnings per share of $3.84 on sales of $289.8 million and the prevailing consensus estimate for $4.34 per share adjusted earnings on $278.1 million in total sales. Following news of the upside surprise in the fourth quarter results, the generous guidance sent the stock soaring in after-hours trading.

Prior to the earnings announcement, the stock had been trading at 22.2 times the prevailing consensus estimate of $4.34 in adjusted earnings per share in FY16. Against the top end of management's guidance range for adjusted earnings of $5.50, this metric implies a price of $122.00 per share. However, traders had been more generous just two months ago, before worries about China growth rates and crude oil prices wore down confidence. In December 2015, as the stock established a new 52-week high near the $112 price level, the stock was valued at 26.0 times the consensus estimate for FY16 adjusted earnings. That multiple suggests the stock could trade to the $143 price level if traders could regain their earlier enthusiasm for Stamps.com.

The recently announced stock repurchase program could have a lubricating effect on valuation as well as share price. The announcement alone could attract traders who follow stock repurchase announcements in anticipation of stock price appreciation that has historically followed buybacks. That said, at the current price level and trading volume pattern, the $20 million budget barely covers one day of typically trading activity. Consequently, we do not expect a measurable impact on price by the stock buyback announcement.

We continue to use the discounted cash flow method to value STMP. The analysis results in a value of $127.00 at year-end 2016. This target price implies a multiple of 30.0 times against our estimate of $4.22 for FY16 earnings adjusted for non-cash expenses, including depreciation, amortization and stock compensation.

The comparable valuation approach provides a possible validation of the results of our discounted cash flow method. Again, we used a group of 203 stocks for companies in the application software sector. Three months ago, the group was trading near 102.3 times free cash flow from operations. However, despite an uptick in volatility in the broader U.S. equity market, the multiple remains near 100 times. Stamps.com could also be compared to a group of 210 companies in the business software and services segment, which is now trading at 50.4 times free cash flow from operations, up from 47.0 times three month ago. While the increase might be surprising given the U.S. equity market sell-off that has been observed over the last few months, the apparent resilience of these two groups is corroborated by the forward earnings multiples of application and business systems software subgroups in the S&P 500 Index, both of which have been on a steady drive higher for the last five years. Only the price/earnings multiple for the application software group has experienced a sharp drop downward over the past two months, nonetheless, remaining over 30 times forward earnings.

The comparable approach implies a value near $200 per share after we applied adjustments to the free cash flow from operations multiples in the groups described in the previous paragraph. Note that we adjusted the comparable group multiples downward by 30% to recognize Stamps.com size and profitability relative to the two groups.

While we anticipate a sharp drive higher in the STMP price, we have some concerns about the potential to achieve the price levels suggested by comparables exercise. Volatility is at elevated levels in the current U.S. equity market and the small-capitalization company sector has recently been under pressure from a rotation to larger capitalization companies with perceived higher quality earnings and therefore lower risk. Accordingly, we have set our price target at $125.00 per share, representing a 30% upside potential from the current price level.

Our price target also corresponds the recent 52-week high price level for STMP. We believe the recent trading patterns in the stock provide support that our price target is achievable. Financial results for the first quarter ending March 2016, should provide a strong catalyst for the stock as we expect the quarter results to validate and confirm the strong results of the quarter just reported.

Disclosure: I am/we are long STMP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.