2023-03-24 11:51:17 ET
Summary
- CPI posted very strong Q4 results across the board, driven by the uptake in contactless cards.
- However, its 2022 results driven by EMV cards are eerily similar to the strong results it reported in 2015 driven by contactless cards, after which the stock collapsed.
- Taking rating down to "Sell."
Ahead of earnings, I put a "Hold" rating on CPI Card Group (PMTS). Let's take a closer look at the company following its most-recent earnings report, which saw the stock jump over 20% the day following its report.
Q4 Earnings
For Q4, PMTS saw its revenue soar 35.7% to $126.4 million . The company easily sailed past analyst estimates calling for sales of $103.3 million.
Gross margins improved 440 basis points to 37.6%. Adjusted EBITDA more than doubled to $27.2 million from $13.6 million a year ago.
PMTS credited the margin improvement to higher operating leverage from higher sales. This more than made up for production inflationary pressures. It is notable that for the full year, gross margins were down -80 basis points.
By segment, Debit & Credit revenue rose 35.5% to $104.9 million. Gross margins for the segment came in at 38.0%, up 440 basis points. EBITDA for the segment was $33.4 million, an increase of 63.7%
The company credited the strong growth to contactless cards, personalization services, its Card@Once instant issuance services. Eco-focused cards were strong, and grew 70% for the full year.
Approximately 75% of its secure card volumes for the year was from contactless cards. The company estimates contactless cards represented between 50-60% of cards in circulation in the U.S. It projects that they will be 80% of cards in circulation by 2025.
Prepaid Debit revenue jumped 39.4% to $22.1 million. Segment gross margins were 34.7%, up 370 basis points. EBITDA for the segment rose 29.4% to $5.7 million.
The company credited growth in new and existing customers as well as pricing for the solid end of the year performance in the Debit segment.
Overall, PMTS generated $16.2 million in free cash flow in the quarter and $13.5 million for the year. It ended the year with $289.7 million in debt, good for leverage of 3.0x. The company did pay down some debt during the year redeeming $20 million in notes in Q1, and it bought an additional $5 million in notes on the open market in Q4.
2024 Guidance
Looking ahead, PMTS guided for sales to grow in the mid-single digits. Meanwhile, it is looking to grow adjusted EBITDA in the mid-single-digit to high-single-digit range, as it plans to more tightly manage expenses. The company says it plans to gain share in a more slowly growing market, while the Debit card business is expected to be about flat compared to 2022.
While the overall results for Q4 and the full year were strong, free cash flow conversion was pretty weak. As such, improving upon the metric is a priority for the company is 2023.
On the call, CFO Amintore Schenkel said:
"We expect to improve cash flow conversion and we project free cash flow to more than double from the $13.5 million generated in 2022. As always, our first priority is to serve our customers. So if business needs or the supply chain environment changes, we may prioritize additional inventory investments, but our current outlook reflects strong working capital improvement and more than doubling free cash flow.
"Within free cash flow, we expect capital spending to be similar to 2022 levels, and we expect to improve our net leverage ratio to somewhere between 2.5x and 3x by year-end through EBITDA growth and net debt reduction. We delivered record results in 2022 and further strengthened our financial position, and we expect another year of progress and financial improvement in 2023 despite the more challenging environment."
Valuation
PMTS trades at 7.3x its EBITDA 2023 consensus of $104.1 million. Based on the 2024 consensus of $117.5 million, the stock trades at a 6.6x multiple.
On a PE basis, its trades at around 15.3x the 2023 consensus of $2.71.
Notably, PMTS only has one analyst that follows the company. That would be Jaeson Schmidt from Lake Street Capital, a small boutique firm from Minneapolis.
The stock trades at a similar multiple to its closest peer CompoSecure ( CMPO ), but PMTS is projected to grow a bit slower and has a bit more leverage.
For its part, CMPO guided for 6-12% revenue growth in 2023 versus mid-single digits for PMTS, and for adjusted EBITDA growth of 7-14%.
Conclusion
The big driver for PMTS continues to be the sale of higher-priced, higher margin contactless cards. However, the story looks very similar to the trends that PMTS was riding in 2015 before the wheels fell off. That year, the conversion to higher-priced, higher-margin EMV cards drove a 43% revenue increase and 78% adjusted EBITDA increase for PMTS.
On the company's Q4 2015 conference call, then CEO Steve Montross said: "Based on recent industry studies, public commentary by the card brands and our own analysis, we estimate less than 50% of debit and credit card issued in the U.S. are EMV at year-end 2015. … We currently anticipate EMV penetration will grow to approximately 90% of debit and credit card issued in the U.S. by the end of 2017."
Compare that to Schnekel saying last quarter: "We estimate contactless penetration for the U.S. market ended 2022 at about 50% to 60% of cards in circulation, and continue to expect the level to grow to more than 80% by 2025."
There is a new management team in place, but the EMV and contactless conversions are following a similar trajectory, where there is big volume growth of these cards. How the management teams describe these cards is also very similar, as they refer to them as having higher prices and more technology behind them.
Penetration, meanwhile, is at a similar level compared to where EMVs were when suddenly there was inventory overstocking by the large issuers. Over-ordering was a common theme in 2021-22 across industries, so it is quite possible this issue could pop up again.
The similarities between EMVs and contactless make be wary, and while leverage has come done, PMTS' actual debt load hasn't been reduced by all that much. As such, I'm going to take my rating from "Hold" to "Sell."
For further details see:
CPI Card Group: Lowering Rating To Sell