ARC - ARC Document Solutions: Needs To Be Cheaper And More Profitable For Us To Start Biting

2023-06-21 17:38:55 ET

Summary

• ARC Document Solutions' shares are trading at the same level as two years ago with the company continuing to run a strong balance sheet and report attractive valuation metrics.
• The company's cash-flow generation has decreased over the past couple of years, with lower free cash-flow-to-sales and asset efficiency ratios compared to 2021.
• Despite the attractive metrics, ARC Document Solutions remains a hold as the share price has not significantly moved, and investors should await further developments.

Intro

If we pull up an intermediate chart of ARC Document Solutions, Inc. ( ARC ), we can see that shares are trading very close to the same level currently ($3 a share) as they were approximately 2 years ago. This gives us a prime opportunity to compare some of the company's key profitability and valuation metrics to what they were 22 months ago post ARC's Q2 numbers in fiscal 2021.

Although risks due to below-average trading volume are elevated in micro-cap companies such as ARC Document Solutions (where a significant seller for example could meaningfully move the market), we must remember that this is a double-edged sword meaning strong buying volume would also have the potential to spike the share-price significantly higher over time.

Furthermore, although shares have remained pretty much rangebound over the past couple of years, we must remember that ARC pays out a $0.05 quarterly dividend which equates to a 6.6% yield on the current share price. Therefore, nominal returns would have been well into double-digit territory over the past 2 years all things remaining equal. Moreover, ARC continues to trade with a very attractive valuation as we can see from the numbers below. It should be noted that the company has a strong balance sheet where both liquidity and solvency metrics remain in sound order.

As much as Wallstreet aims the lion's share of its focus on a company's earnings, considering the attractiveness of ARC's ultra-low cash-flow multiple of 3.45, we will concentrate our study on the company's cash-flow trends with respect to ARC's profitability and valuation. At the end of the day, cash creates earnings which means if the metrics below come in at a better standing than in mid-2021, this would stack the odds in favor of shares of ARC being able to rally to the upside over time.

Free Cash-Flow To Sales Ratio

First to profitability and the free cash-flow-to-sales ratio. This ratio informs us of how much earnings (Free cash flow) is essentially earned from sales in a given period (after capex expenditure has been accounted for). ARC's free-cash-flow generation over the past four quarters amounted to $31.2 million. Revenues in ARC have amounted to $285.4 million over the same period. Therefore, when we use the formula below, we get a trailing FCF/Sales ratio of 10.93%.

Now, if we go to ARC's Q2 numbers in fiscal 2021 and work back four quarters, trailing 12-month sales amount to $267.2 million. Free cash flow in this period amounted to $39.7 million. Suffice it to say, when we plug the above numbers into the same formula, we get a free cash-flow-to-sales ratio of 14.86%.

A few takeaways from the above. Although capex spending over the past four quarters came in higher ($1.4 million) over the latter period, margins from a free-cash-flow perspective have still dropped over the past couple of years. This means less cash is being converted from ARC's top-line sales all things remaining equal.

Cash-Flow To Assets

It is important however not to rely on one single metric. Assets for example are essentially what create ARC's sales. Moreover, operating cash flow can be a better number to use when capex spending is not consistent. Suffice it to say, this ratio (Cash from operations / Assets) lets us know how well ARC is able to generate cash flow from its assets. At the end of Q1 this year, trailing operating cash flow came in at $38.1 million and total assets totaled $303.5 million. Dividing cash flow by the asset count gives us an asset efficiency ratio of 12.55%.

Again, if we revert to 2021, we calculate trailing 12-month operating cash flow (Up to Q2-2021) to come in at $45.2 million, and total assets at the end of Q2-2021 amounted to $330.3 million. This means that ARC's asset efficiency ratio came to 13.68% which means that once more we see the company falling short of the 2021 comparable.

Price To Free Cash Flow (Valuation)

From a valuation perspective, if we divide ARC's trailing 12-month free cash flow by the company's market cap, we can see how much each dollar of free-cash-flow costs ARC Document Solutions to generate. Suffice it to say, currently, ARC Document's trailing free-cash-flow multiple comes in at an ultra-low 4.22. Given that ARC's share count was lower at the end of Q2-2021 (43 million as opposed to 43.6 million currently) and free cash flow was higher at the time, we again see that the 2021 comparable comes in more attractive at close to the 4 mark.

Conclusion

To sum up, although ARC Document Solutions' profitability and valuation metrics from a cash-flow perspective look very attractive at present, they were actually better 2 years ago when these conditions at the time failed to move the share price in earnest. Suffice it to say, ARC Document Solutions remains a hold for us here until we await further developments. We look forward to continued coverage.

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