CA - Transcontinental: Q4 Results Support Dividend Yield And Upside

2023-12-27 14:28:53 ET

Summary

• Transcontinental reported decent quarterly results despite macroeconomic pressures.
• The company distributed four quarterly dividends of $0.225 in FY2023, totaling an annual dividend of $0.90 per share and representing a dividend yield of 6.63% compared to current price.
• The company has a strong dividend yield and is undervalued, with potential upside of 23-27% growth.

Investment Thesis

Transcontinental ( TCL.A:CA ) is a flexible packaging and printing company in North America. It reported its quarterly results and has managed to deliver decent performance despite the macroeconomic pressures. I believe the company can further grow in the future as it has highly focused on the commercialization of recyclable flexible packaging which can accelerate its growth by offering innovative sustainable solutions.

About Transcontinental

Transcontinental provides flexible packaging operating in North America and is known as the largest printer in Canada. The company conducts its business in three segments: Packaging, Printing, and Media . The Packaging sector offers various flexible packaging products and services specialized in printing, lamination, extrusion, converting, and recycling. This segment contributed approximately 56.30% to the company’s total revenues in 2022. Its portfolio is highly diversified with more than 35 products in different categories of beverage, snacks, agriculture, consumer products, meat and poultry, advanced coatings, medical, pet food, and many more. The Printing sector provides a comprehensive line of services to produce printed material, comprising a complete process of graphical production. It also operates a distribution business where it delivers advertising printed products, flyers, and newspapers in Quebec to approximately 3.3 million households. This segment contributed approximately 40.80% to the company’s total revenues. The Media sector manages education and trade publishing and book distribution through TC Media Books. It also comprises Groupe Constructo which deals in publishing value-added information for players in the construction industry. This segment represented approximately 2.90% of the company’s total revenues.

Financials

The packaging industry experienced a downturn due to the negative impacts of the pandemic. However, the scenarios are completely changing which has made a positive long-term outlook and led to an upside in this sector due to various factors. The increasing prominence of flexible packaging to reduce wastage, especially in the food segment has resulted in large requirements. The North American region has the highest rates of dairy consumption and is expected to increase in the next decade mainly due to consumer food choice and population growth. I believe this presents great opportunities for the companies operating in this industry. In addition, sustainable solutions are essential to protect the environment which has increased the need for recycling. Identifying all these trends, the company has decided to invest approximately $60 million in developing cutting-edge mono-materials as a part of flexible plastic packaging solutions. This mainly offers heat resistance with high-performance polyethylene films. This line will develop biaxially oriented polyethylene (BOPE), which will be the first in North America. The capex also comprises ancillary equipment and a building expansion of 120,000 sq. ft in the South Carolina Facility. I believe the increased offerings can act as a catalyst to boost the company’s growth as the new sustainable solution can help it differentiate itself in the market, giving it a competitive advantage and facilitating it to capture an additional market share. This deep penetration in the market by commercializing its recyclable flexible packaging and offering innovative products to the customers can increase its profit margins in the future.

The company has r eported its quarterly results on December 12th. It re ported a revenue of $779.70 million, down 2.80% compared to $802.20 million in Q422. This growth was mainly resisted due to lower volumes and variations in exchange rates for packaging. Net income decreased by 30.96% YoY from $60.40 million to $41.70 million. The asset impairment charges and increased financial expenses led to this decline. It reported a diluted EPS of $0.48. The company has managed to beat market's EPS estimate by 2.13% or $0.01. The Packaging, Printing, and Media segment revenues were $420.80 million, $311.30 million, and $47.60 million respectively. TCL.A reported $137.00 million in cash and adjusted EBITDA stood at $145.50 million.

It has also reported its FY2023 results. It has recorded revenue of $2.94 billion, which is 0.52% YoY decrease compared to $2.95 billion in prior year. It was mainly caused by low printing volumes. Net income dropped by 39.20% YoY from $141.20 million to $85.80 million. It reported diluted EPS of $1.63. It recorded adjusted EBITDA of $446.5 million in FY2023.

Transcontinental’s resilient business model is reflected in its strong quarterly results. Though the volumes were lower it has managed to maintain a decent revenue level through organic growth. It expects the printing orders can remain on a downside for the next year, however, there is a high demand for flexible packaging. It has increased its capex to address this rapidly growing demand and I believe this can help the company to increase its profit margins by offering distinct solutions.

Dividend Yield

The company has a consistent dividend payout which indicates its strong positioning. It distributed four quarterly dividends of $0.225 in 2023, totaling an annual dividend of $0.90 per share and representing a dividend yield of 6.63% compared current price. This dividend yield makes the company an attractive stock, especially for risk-averse and retired investors who are seeking fixed regular income along with capital appreciation. Observing the current demand trends in the industry and the company's resilient business model with healthy cash flows, I think it can increase this payout in the future.

What is the Main Risk Faced by Transcontinental?

The company uses raw materials such as paper, plastic film, resin, ink, and plates. It depends on various suppliers to obtain these products. If the supply of these components gets disrupted, it might negatively impact the company’s ability to serve its customers and might contract its profit margins. The geopolitical conflicts can also lead to supply chain issues, including other reasons such as climate disturbance, and transport disruptions. In addition, if their prices increase and the company fails to transfer them to the customers, it can affect its net earnings.

Valuation

The packaging industry is growing rapidly however, it has been emphasized more on sustainable solutions. This has induced demand for such products in the market. I think the firm is positioned well to cater to the growing demand as it has recently planned to expand its offerings which can help it to increase its market share and profitability by adding on more customers. After considering all these factors, I am estimating an EPS of $2.44 for FY2024 which gives the forward P/E ratio of 5.56x. After comparing the forward P/E ratio of 5.56x with the sector median of 9.38x, we can conclude that the company is undervalued. I think the firm can potentially grow in the next year as a result of positive demand in the industry and its increasing investments which can help it to trade above its current P/E ratio. I estimate that the company might trade at a P/E ratio of 7.06x in 2024, giving the target price of $17.22, which is a 26.94% upside compared to the current share price of $13.57. Reduced sales due to supply disruptions can affect financial performance of the company during adverse economic conditions. I think in that case, it can contract profit margins and EPS of the company.

I believe in bear case scenario of reduced sales due to supply disruptions, the EPS of FY2024 might be $2.39, and estimate that the company might trade at a P/E ratio of 7.00x, which gives target price of $16.73, representing upside of 23.28%.

Conclusion

The company has reported strong quarterly results despite adverse macroeconomic conditions. I believe it can sustain this performance in future as it has increased its investment in commercializing its recyclable flexible packaging by developing innovative and sustainable solutions that can attract more customers and increase its profit margins. However, it is exposed to risk of supply chain issues which can contract its profitability. It also has consistent dividend payout which makes it appealing investment opportunity. The stock is currently undervalued and we can expect decent growth of 23%-27% from the present price levels as result of its increased capex and strong industry dynamics. After considering all the above factors, I assign a buy rating to Transcontinental.

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