It's not often you get a stock paying a dividend yield greater than its average bond yield. It usually means the company is in distress or there is significant turmoil in the financial markets. Although there is still great economic uncertainty around the world today, the market we're in now is not 2008 all over again. And although the company in question, RR Donnelley (NASDAQ:RRD), certainly has its challenges, I don't think the word distressed would be applied under any circumstances.
The company currently has outstanding bonds with coupons ranging from 7.25% to 8.6% for maturities between 2016 to 2020. Most of the bonds are trading reasonably close to par so the effective yields range from 7.0% to 8.5%. R.R. Donnelley's dividend yield based on a $11.43 stock price would be 9.1%.
Let's look at the dividend first and then the business. R.R. Donnelley offers a $1.04 annual dividend (paid quarterly) and has paid a cash dividend since 1985. The company has provided 2012 EPS guidance in the range of $1.84-$1.92 excluding extraordinary items.
However, these earnings include non-cash amortization for intangible items such as trademarks and customer relationships. Adding back the company's estimated annual intangible amortization of $90 million for 2012 and tax-affecting it to be conservative would provide a cash EPS range of $2.18-$2.26.
Anyway you look at it, R.D Donnelley's dividend payout ratio is somewhere around 50%, very acceptable for a mature, low growth, high free cash flow company. R.R. Donnelley can certainly miss guidance like any company, but a material miss to bring its payout ratio above 100% is highly unlikely. Double checking the free cash flow availability to continue paying the dividend, the company expects free cash flow after capital expenditures of at least $500 million in 2012. The amount of cash dividends payable is approximately $190 million annually which leaves an enormous cash cushion in case things turn south, or the company is completely off the mark in its business forecasting.
This is an interesting and perhaps rare anomaly that exists now between its dividend yield and bond yields. Looking at the business itself might provide an answer. R.R. Donnelley is the largest commercial printer in N. America, or as it describes itself now - a global provider of integrated communications. The company prints books, retail inserts, magazines, catalogues, manuals, billing statements, healthcare documents and IPO prospectuses just to name a few. The company also operates a logistics business and various digital businesses.
Its revenues in 2011 were $10.6 billion with its next 3 competitors, Quad/Graphics (NYSE:QUAD), Transcontinental [TSX:TCL.A] and Cenveo (NYSE:CVO) at only $4.3 billion, $2.0 billion and $1.9 billion in revenues, respectively. The U.S. print market excluding newspapers is about $110 billion in size, so the industry is still highly fragmented. The global print market excluding newspapers is approximately $275 billion. The digitization of the world and the rapid growth in desktop or mobile based reading provides the company with many challenges, however they have tried to offset these trends with various digital initiatives (and many technology related acquisitions). These newer products and services include digital book distribution for e-readers and SaaS type businesses for integrated direct and digital marketing.
This evolving technology business dynamic around the world has obviously hurt the company's business and growth rates, however through market share gains, acquisitions and newer digital initiatives, the company should grow its top line at least at GDP rates. With judicious expense management, interest expense declines as debt is paid down, and the use of share buybacks, R.R. Donnelley should be able to grow its EPS at a rate well exceeding its revenue growth. That means it's dividend appears safe in the near-to-mid term. The company is trading at 6.0 X 2012 EPS and 4.4 X 2012 EBITDA, and with a valuation so low, it doesn't make sense to own the bonds compared to the stock.
I have no idea if this company is a short target for those who partake in that sort of thing. But when fixed income holders switch from the bonds to the stock to get a higher yield while enjoying the very likely chance of a highly valued, embedded call option on the equity, it will probably be a short target no more.
Disclosure: I am long RRD.
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