2023-08-24 07:38:20 ET
Summary
- Despite significant banking turmoil, PMTS grew 2nd qtr. revenue single digits and EBITDA mid-teens demonstrating its resilient recurring business model.
- Some of the company’s 27% growth in 2022 was due to excessive channel inventory, which should dissipate in Q4 2023 unmasking secular growth.
- The new CEO should be a catalyst as they would reengage with investors bringing new institutional investors into the stock.
- Mispriced stock with a valuation of 7x P/E, which is too low compared to 25x to 27.5x for the S&P and Russell 2000, respectively.
- We believe PMTS will earn $5 EPS by 2025, and a moderate 15x P/E multiple yields a $75 long-term target tripling today’s value.
Summary
CPI Card Group Inc., (PMTS) is a leading credit and debit card manufacturer in the United States. The company's financial performance has improved due to market share gains, industry growth, and ((ASP)) expansion. The company's fundamentals are resilient with 90% of its revenue recurring due to lost, stolen, damaged, or renewal card demand. The credit card industry experienced a 10% ((CAGR)) over the past 3 years driven by secular changes from cash to card usage. Over the past three years, PMTS' revenue has increased organically by nearly 100% outpacing industry growth due to market share gains and higher (ASPs) from ((EMV)) to contactless cards migration.
Q2 2023 Results
On 5/09/23, the company released strong 1st quarter earnings, but guided second quarter lower compared to prior year due to banking turmoil associated with three failed regional banks. The company then significantly exceeded its guidance in the 2nd quarter by posting revenue growth of 1.4% and generating EBITDA growth of greater than 15% year over year. For the year 2023, the company guided to flat to single digit revenue growth and EBITDA growth of mid-single digits implying approximately $100MM of adjusted EBITDA or $3.48 adjusted ((EPS)) for 2023.
Why Believe Guidance
The company has a history of providing conservative guidance and beating it. This occurred in 2022 when revenue and EBITDA growth doubled initial guidance and again in the first and second quarters of 2023 when the company substantially beat guidance. Additionally, the stock is trading at a severely mispriced multiple of less than 7x P/E compared to 27.5x P/E and 25x P/E for the Russell 2000 and S&P 500 , respectively. Multiples this low are usually indicative of cyclical businesses like steel manufacturing, ((DRAM)) etc. We believe PMTS should trade around 15x P/E once people realize the stability and resiliency of the business.
Resilient Business Model
Despite significant financial turmoil in the banking sector in the second quarter 2023, the company posted 1.4% revenue growth off a comparable of 21%. The company also grew adjusted EBITDA by 15% through steady revenue generation and expense management. These results are a testament to the resiliency of the company's business even as new marketing programs were delayed due to tighter expense controls. Notably, the vast 90% of revenue demand is recurring, which provides significant revenue stability.
We believe the larger driver of revenue headwinds is related to channel inventory that is being worked off. The chip shortage during the pandemic caused some customers to buy more cards than needed. This channel inventory has been discussed during previous calls. The channel inventory probably isn't too significant as hoarding was curtailed by the shortage of chips to produce cards and this bottleneck in the system was alleviated about 9 months ago.
Once channel inventory dissipates the secular drivers evidenced by the growth in cards in circulation of 10% CAGR over the past 3 years will once again drive at least mid-single digit revenue growth for PMTS. The number of financial accounts drive card circulation and people today are increasingly holding multiple accounts through both fintech and traditional banks. The company has various new offerings to satisfy this growth from personalization of cards, card material like tungsten metal to eco-friendly cards made from ocean bound plastics. The chart below illustrates PMTS' intrinsic value based on multiple of earnings and EV/EBITDA. Based on management's guidance and a 14x EPS or 8.7x EV/EBITDA multiple, PMTS would be valued at $50 per share.
Created by author using company filings
Catalysts
Announcing a new ((CEO)) - Scott Scheirman, the current ((CEO)), announced he will be stepping down by 2/28/2024. This puts the company in investor relations limbo as institutional investors need to speak with the person running the company in order to invest. We noticed John Lowe was reintroduced on the last earnings call. Mr. Lowe was the previous ((CFO)), and is presently the ((EVP)) of End-to-End Payment Solutions responsible for 80% of the company's revenue. Mr. Lowe has presented at various investor conferences over the past two years. We believe he would be a great ((CEO)) as he was a crucial part of the team that turned around the business operations and successfully negotiated two debt amendment/refinancings during his tenure.
Strategic M&A - the company disclosed that it could pursue strategic acquisitions. We believe a deal that could consolidate the industry would have significant synergies, by creating a larger company and strengthening the industry with greater pricing stability. A well-structured deal could send the stock significantly higher than our ultimate $75 price target.
Additional Sell-Side Coverage - the company has been at several institutional investment conferences and meeting with sell-side analysts. We believe this should lead to new coverage.
Tricor 58% Shareholder - as we discussed in our first report, Tricor has made a lot of money in PMTS over its nearly 14 year holding period. We believe it inevitable that Tricor will sell shares, creating two catalysts: firstly, enticing sell-side coverage as Tricor would sell through a secondary offering, and secondly, it would remove the share overhang allowing for a less concentrated shareholder base and more liquid float.
Returning Capital - the company should generate over $3 of cash earnings in 2023 allowing for a dividend or share buy backs.
Margin Of Safety
The company's business is resilient and has secular growth drivers evidenced by increased cards in circulation, as well as expanding (ASPs) through contactless conversion that should contribute about 3-4% to revenue growth annually through 2025. We believe the company should at least grow mid-single digits and double digits EBITDA in a steady state economy.
Financial pundits have been calling for a recession and we wanted to stress the model to show earnings variability despite our own view that a severe recession remains unlikely given the 3.5% unemployment rate. During the 08-09 Great Recession the company's revenue declined over 10%. We believe a 10x P/E for a moderately levered company is a very cheap recessionary valuation multiple. Our sensitivity model suggests a 12.5% revenue reduction along with lower margins than the past 4 years would lead to $2.19 ((EPS)). We believe the present trading price of PMTS provides significant margin of safety.
Stress Test Model
Created by author using company filings
Base Model Annual
Created by author using company filings
Base Model Quarterly
Created by author using company filings
Conclusion
PMTS is a very mispriced stock given historical and anticipated results with a massive below market multiple. Investors who purchase stock now are getting a significant value discount because the market misunderstands the resiliency and lack of cyclicality. The company has many drivers including pricing, market share increases, and contactless conversion that should drive revenue growth for years to come. Sell-side coverage should improve the company's visibility, and if the company can execute, we will see a stock worth $75 once the market realizes earnings will be greater than $5 per share.
Lastly, the company has been discussing potential acquisitions. One potentially interesting situation has emerged with Idemia's private equity owner rumored to be considering selling or breaking the company up. According to Reuters, Idemia has hired Goldman Sachs and Rothschild as bankers to run a sales process. If a deal whereby PMTS buys part of Idemia could be structured, it could increase operational scale and efficiency, promote greater industry pricing stability, and increase share float, which would alleviate the illiquidity discount for PMTS shares allowing for our target price of $75 to be exceeded.
For further details see:
CPI Card Group: A Compelling Value Investment