Expect Continued Progress In Data Communications Management Turnaround

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Includes: DGPIF
by: Scott Nirenberski, CFA

Summary

The second quarter is usually one of DCM's seasonally weaker quarters, however, I expect results to show continued progress in the turnaround.

Legacy print execution declines remain manageable as continued cost reduction efforts and impact from recent acquisitions play an increasingly positive role in 2H2018.

Expect DCM to reiterate guidance for 2018 as it is readily achievable and there is really no reason to go out on a limb particularly in light of the current valuation.

Perennial will not have much impact on second quarter results as there were only 6 weeks of results in the quarter. Despite minimal impact to DCM's second quarter, the integration appears to be going smoothly.

This note serves to provide a brief update on DCM as a follow-on to the in-depth note I published on June 12, 2018.

Recent industry checks and discussions with management suggest current business trends are progressing similarly to the last two quarters so DCM's 2Q2018 should mark the third consecutive quarter in which the turnaround strategy manifests itself in the company's reported results.

Second quarter is a seasonally slower quarter and I believe this year was no different. I would expect continued year-on-year growth driven by new customer ramp, acquisitions and offset partially by manageable declines in the legacy print execution business. Outside of this, paper prices are moving higher and these prices are being passed along to customers across the industry. I would expect this to drive some front-loading of sales as customers look to take advantage of current prices before increases occur driving higher paper sales on lower margins. For reference this is the SAME as what occurred in 1Q2018 so there is nothing new here.

Based on what I see as another solid turnaround quarter and summer seasonality, I would expect DCM to reiterate guidance for 2018. Guidance is very much achievable but if I were management, I would not see a reason to increase it as the stock remains highly undervalued given free cash flow generation. Simply put, continued solid execution should be enough to drive the stock higher at current valuation levels so no point in wasting dry powder.

More intriguing is 2H2018, where a number of continued cost reduction efforts (think facilities optimization), full impact of Perennial, top line growth from new and existing customers and the launch of the new Microsoft ERP system should come together to make meaningful gains in gross and operating margins. I did receive a question regarding the impact of the ERP system and while it is always a hard item to quantify, I would estimate annual savings of $2+ million for 2019 or 70 - 100bp positive impact to operating margins based on reduction in personnel and the ability to run a larger business with less staff. So the underpinnings of continued margin expansion in 2019 are there and should not be overlooked. Overall, I am estimating DCM will exit 2018 with EBITDA margins in the 8.7 - 10.0% margin range from the 8.1% reported in 1Q2018 and 4.3% in 4Q2017. 2019 should see further gains in EBITDA margins from the ongoing efforts and growth in DCM's top line.

Perennial Enabling New Customers and Increase Wallet Share

Recall that Perennial has been working with DCM for 18 months, which is why the integration is running smoothly. While Perennial's efforts to help DCM's go to market strategy are paying off in enabling DCM's salesforce to garner customer wallet share increases with existing customers, new avenues of growth are beginning to come into focus.

Perennial and DCM are opening the door to begin discussions with each other's customers that were previous not served or were underserved. Furthermore, a complete solution from marketing strategy planning all the way through execution of digital and print communications is enabling growth in average customer engagement not just from large accounts but from the mid market ($500K - $3 million) too. Together this provides four new avenues of growth: new customers for DCM, new customers for Perennial, increased wallet share at DCM customers and increased wallet share at Perennial customers. It is also important to realize that mixing in higher margin marcom services will very likely push margins higher on the higher average sales providing a double whammy to operating margins over time.

Disclosure: I am/we are long DGPIF.

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

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