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Introduction
4Imprint (OTCPK:FRRFF) has been a longstanding holding in our portfolio since 2015, and the share price has tripled from 1,056p at our initial entry to around 3,000p at present. However, the share price has been volatile in 2020 year-to-date, going as high as 3,500p and as low as 2,720p:
| 4Imprint Share Prices vs. FTSE All-Share (Last 6 Months)
Source: Yahoo Finance (05-Mar-20). |
Following 2019 results this Tuesday, we review our investment case here.
Company Overview
4Imprint is a U.K.-listed but primarily U.S.-focused business, founded in 1985 and now has a $1bn market capitalization.
The company is a distributor of branded promotional merchandise used by businesses in their marketing activities. 97% of its revenues are in North America (the rest in the U.K. and Ireland), and are primarily from Small and Medium Enterprises ("SMEs"). It sells a variety of merchandise including bags, apparel, writing materials, drinkware, stationery, etc.:
| 4Imprint Direct Marketing Revenue by Product Category
|
Approx. two thirds of 4Imprint's revenues are generated by direct marketing, the other one third by long-term contracts. 4Imprint sources the products from suppliers after customer have placed their orders, and facilitates their deliveries to the customers (often direct from suppliers). It has just over 1,000 employees (2018), with 45% of them working in Sales & Marketing.
Strong Double-Digit Growth Record
4Imprint has a strong growth record, having doubled its underlying EPS since 2014, with revenue and EPS each growing by 10% or more each year:
| 4Imprint EPS & Year-on-Year Growth Rates (2015-19)
Source: 4Imprint company filings. |
EPS growth was partly helped by a falling tax rate, especially the 2017 U.S. tax cut, which enabled 4Imprint to spend more on marketing in 2018 while still growing EPS by more than 20%. However, 4Imprint's record of strong revenue growth is real, and growth has re-accelerated to high teens in 2018 and 2019.
Management strategy is "to maximize revenue growth while maintaining a broadly stable operating margin", and margins have been fairly consistent in the last 5 years. The slight decline in EBIT margin since 2017 has been due to increased marketing costs that helped push revenue growth higher:
| 4Imprint Margin Profile (2015-19)
Source: 4Imprint company filings. |
4Imprint's double-digit growth, which we expect to continue for many years, is due to a number of structural factors, as we will explain below.
#1 in Fragmented Market
4Imprint is the #1 market leader by far in a fragmented market. In 2019, it had $861m sales in the U.S. and Canada; most competitors are far smaller - there are approx. 23,000 distributors in the U.S., of which more than 90% have less than $2.5m in sales. The size of the market is $28.8bn, which means 4Imprint's share is still less than 3%, leaving it plenty of room to grow:
| 4Imprint US & Canada Revenues vs. Market Size (2015-19)
Source: 4Imprint results presentation (2019). |
The overall market remains healthy, with the total value of U.S. promotional merchandise estimated to be growing at approx. 5% annually.
Recurring Business with Growing Customer Base
4Imprint promotional merchandise tend to be a key part of its SME customers' promotional activities. It is thus fulfilling an ongoing, mission-critical need for customers, which means its revenues are highly-recurring.
It also has good customer retention - the percentage retained for 24 months or more has been stable in the 42-43% range in the last few years:
| 4Imprint U.S. & Canada Customer Number & Retention (2015-19)
Source: 4Imprint results presentation (2019). |
4Imprint's base of existing customers has continued to grow, and typically generate nearly ⅔ of its orders each year:
| 4Imprint Customer Orders - Existing & New (2014-19)
Source: 4Imprint company filings. |
Capital-Light, "Many-to-Many" Platform
4Imprint's role is one of a "many-to-many" platform, which gives it strong pricing power but low CapEx needs, and a high Return on Capital.
It is a technology-based distributor between hundreds of thousands of customers and a large base of suppliers:
- Customers prefer "one stop shops" to consolidate their needs into fewer orders. At the same time, with 1.587m customized orders in 2019, the cost of each order to the customer is low (averaging $540). So customers tend to be less price-sensitive and gravitate towards larger platforms
- The supplier base is diverse, most individual items have easy substitutes, but few suppliers on their own can provide the full range (tens of thousands) of products that customers can order. So suppliers depend heavily on 4Imprint to generate orders
These dynamics give 4Imprint good pricing power with both customers and suppliers.
Most orders are directly shipped from suppliers to customers, without 4Imprint holding stock, so its platform is highly-scalable with low CapEx needs and a high Return on Capital. (Return on Capital Employed was 84% in 2018.)
Re-accelerated Growth from New Ad Strategy
While consistently in double-digits, 4Imprint's revenue growth has re-accelerated from low-teens in 2016-17 to high-teens in 2018-19:
| 4Imprint Revenue Growth (2015-19)
Source: 4Imprint company filings |
A key driver of this re-acceleration is a new ad strategy (announced with 2017 results) that has shifted resources into "brand advertising" (TV and radio), from digital advertising (especially Google Words). This has proven far more cost effective due to the rising costs of digital advertising, and has the advantage of building the 4Imprint brand in consumers' minds.
Volatility During Downturns
While 4Imprint has demonstrated strong growth across the cycle, its financials could be volatile during downturns, as customers cut down on marketing. However, such downturns tend to be followed quickly by strong rebounds.
In the 2008-09 crisis, 4Imprint's Profit Before Tax and EPS both fell 40% year-on-year in 2009 as prices were cut to maintain revenues, but then more than caught up again in 2010:
| 4Imprint Financials During Great Financial Crisis (2008-12)
Source: 4Imprint annual report (2012). |
4Imprint's share price could be similarly volatile during downturns. Between 2008 and early 2009, it fell by more than 60%, but then more than tripled from the lows by the end of 2010:
| 4Imprint Share Prices vs. FTSE All-Share (2008-10)
Source: Yahoo Finance (05-Mar-20). |
Covid-19 Impact
4Imprint has so far not been impacted by Covid-19, though this may change.
The company's supplier base is largely domestic in each market, but these suppliers in turn often rely on imports. According to management estimates, 60% of the blank stock for 4Imprint's products are from China.
Because of the inventory originally built up by suppliers for the Chinese New Year, the impact of Covid-19 "has so far been minimal". As the company explained in their 2019 results announcement:
"The fact that the outbreak occurred around the Lunar New Year means that most of our domestic suppliers were at peak inventory levels when the outbreak began - they typically place orders in preparation for the first half of the year to be delivered, or to be in transit, before the Lunar New Year begins. As a result, to date there has been almost no impact on 4imprint from COVID-19 … The reduced capacity seen in February, and even into March, is unlikely to cause major disruption in the short-term simply due to the inventory cycle of our domestic suppliers"
However, there would be more impact if the supply chain disruption were to persist, or if Covid-19 were to have a wider impact globally.
We believe the worst case scenario would be similar to the 2008-9 crisis, with a severe impact for one year, but quickly followed by a rebound.
Valuation
At 3,030p, on 2019 financials, 4Imprint shares are on a 25.4x P/E and 3.2% Free Cash Flow ("FCF") Yield; the Dividend Yield is 2.2% ($0.84).
FCF has been volatile in last few years, due to working capital, expansion CapEx at the Oshkosh head office, changes in tax rate, pension contributions, etc. We have made our own normalizing adjustments, which gives us a 2019 FCF figure that is similar to management's, and a far smoother FCF path since 2015 that gives a CAGR of 15.2%:
| 4Imprint Earnings, Cashflows & Valuation (2015-19)
Source: 4Imprint company filings. |
4Imprint's dividend policy is for the regular dividend to "increase broadly in line … through the cycle" with EPS, and to be "at least" maintained in a downturn. The company has also historically distributed surplus cash through special dividends. Overall, 80% of the FCF (management definition) in 2015-19 was paid out as dividends.
4Imprint has a small defined benefit pension deficit ($12m), more than covered by its $41m of net cash. A $10m lump sum payment has been agreed for May 2020, and ongoing contributions (including administration costs) will be £2.76m in 2020 and increasing by 3.0% a year, similar to prior years.
CapEx will be elevated in 2020, with $4.7m to be spent on "embroidery/DTG equipment" and $3.2m on the office and distribution facilities in Oshkosh.
Conclusion
4Imprint is a unique asset, with a strong business model and the potential to double in size every 5 years (based on low-teens annual growth).
At 3,030p, with a 3.2% FCF Yield, the valuation is reasonable, though both earnings and the share price could be volatile during downturns.
We believe 4Imprint can double its share price over the next 5 years, given stable valuation, in line with the growth in its business. This implies a share price CAGR of approx. 15% over 5 years, which with its 2.2% Dividend Yield gives a combined high-teens average annual return for investors.
Our rating on 4Imprint is Buy. We are retaining our holding, but are tactically keeping our position small to allow a further increase if the shares were to fall more in the current volatile markets.
Note: A track record of my past recommendations can be found here.
