ARC - ARC Document Solutions: Sluggish Top-Line Growth Taking Its Toll On Share Price

2023-11-29 08:00:00 ET

Summary

• ARC Document Solutions has lost over 13% of its value in the past 3.5 months due to sluggishness in the plain paper printing segment.
• The company's dividend yield is currently at 6.9%, but the dividend payout ratio is entering 'dangerous' territory.
• The lack of top-line growth in ARC is causing concern in the market, and shares continue to be only recommended as a hold.

Intro

We wrote about ARC Document Solutions, Inc. (ARC) back in mid-September of this year when we were eyeing up a potential long-entry into the stock. The company's sizable dividend & sustained growth in ARC's digital color printing & scanning businesses in Q2 (the latter in particular) were key reasons why we believed the stock would ultimately trend higher. Fortunately, though, we did not stamp a buy rating on the stock as there still was a question to be answered on the technical side. Suffice it to say, that ARC failed that test as shares failed to bounce off underlying support which has resulted in shares losing more than 13% of their value over the past 15 weeks approximately.

What investors need to understand here is that ARC has now failed to take out overhead resistance on multiple occasions over the past couple of years. The longer, this trend continues, the more difficult it will be for shares to finally trade above the $3.50 to $4 level. Therefore, given the current share price ($2.90 approximately), one needs to ask how much upside is really on offer in ARC at this present moment in time. The stock's upside (despite its keen valuation ) may actually be considerably less than one may estimate.

Apart from the growing overhead technical resistance, elevated interest rates continue to dampen demand in ARC's plain-paper printing segment, which consequently lowers demand for associated equipment. High interest rates directly affect the construction industry, and it is still an unknown at this point when demand will increase for new-builds once more.

The problem from ARC's standpoint is that digital color & document scanning (although both growing) are not big enough nor growing fast enough to compensate for the sluggish plain paper printing side of the business. Furthermore, despite the bullish fundamentals in digital color (repeat business with top brands, growing pipeline, etc) & scanning (elevated amount of booked work, growing pipeline, responsive marketing, etc.), overall company sales growth remains negative. Furthermore, our thesis in September was based on certain earnings projections at the time. However, as we see below, the forward-looking EPS projection for this fiscal year has been revised down in recent months by almost 7% which doesn't offer hope that a swift turnaround is at hand here.

Therefore, considering how events have changed over the past 3+ months, we think it is prudent to revisit the dividend and its associated trends to ascertain whether ARC at its current price point remains a sound investment for the value-oriented investor.

Dividend Safety & Growth Prospects

The decline in ARC's share price has now spiked the dividend yield to 6.9%. ARC's GAAP dividend pay-out ratio now comes in at approximately 80% over a trailing 12-month average, which means the ratio is entering 'dangerous' territory. Long-term investors may dispute this given ARC's capability of generating cash flow as well as the expected 17%+ bottom-line growth next year. Projections though as we have seen can change on a dime which means the present dividend pay-out ratio must be respected and watched closely in upcoming quarters.

The quarterly dividend payout of $0.05 per share has remained the same since January'2022 demonstrating a no-growth strategy regarding the payout. To compensate investors, management has been buying back stock ($9 million left in the current budget where $1 million of shares were bought back in Q3), thus increasing shareholders' stakes in the company. However, we find it surprising that the quarterly dividend payment of approximately $2.1 million has not been coming down (given a supposedly lower share count). This is confirmed in the company's share count (43 million approx) which also has not been coming down as expected on the income statement. Suffice it to say, that investors should not rely on share buybacks to boost the company's EPS over time.

Yields On Comparable & Alternative Investments

Although companies such as NL Industries, Inc. (NL) & ACCO Brands Corporation (ACCO) which also operate in the 'Offices, services & supplies' industry currently report dividend yields of 5.34% & 5.68% respectively, this is not the norm in this industry as we see here . Furthermore, an alternative investment such as the 10-year US Treasury bond pays a yield of approximately 4.4%. Suffice it to say, ARC's prevailing dividend yield comes in much higher than both a long-term 'secure' bond investment as well as the average in its industry. Therefore, since dividend yield is a pretty good proxy for risk in a respective investment, if we continue to see ARC's yield go further above the above-mentioned benchmarks, this trend would add risk to the company's dividend over time.

Capital Gain Potential Of Shares

To ensure the dividend at least remains at $0.20 per year, we must see sustained earnings growth. Although consensus as mentioned expects double-digit earnings growth next year as shown, it seems the market remains oblivious to ARC's growth path due to how revenues have been trending. The problem with stagnant revenues is the fact that it puts extra focus on cost-cutting initiatives (whether this be staff or inventory cutbacks) which is the polar opposite mindset needed for winning. Furthermore, there is always a time element with respect to how financially disciplined a company can remain in that costs can only be cut so far over time. Sustained revenue growth is also a crucial metric regarding the viability of a paying dividend in the long run.

Conclusion

To sum up, ARC Document Solutions has lost more than 13% of its value over the past 3.5 months. Slugginess in the plain paper printing segment resulted in both a sales and earnings miss in the recent third quarter. Although boasting a strong balance sheet & almost 7% dividend yield, the market continues to read into the lack of top-line growth in ARC. Shares remain a hold. We look forward to continued coverage.

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