PMP: pressing on

The investment case for PMP, first outlined in PMP: back from the brink, remains intact and is arguably stronger now than it was when we first made the case. The turnaround of the business, ongoing for the past three years, is now complete.

Assets have been sold, net debt has been reduced from over $140m to just $19m, the workforce has been cut in half and about $90m in annual costs have been stripped out. Death no longer stalks the business and it is now largely a printer and distributor of catalogues along with a small book printing business and a small (profitless) magazine distribution business.

You might expect that a printing business would struggle in the digital age. Yet, over the past three years, PMP has generated over $100m in free cash flow and we think it can continue to generate around $30m a year for several years. With a market capitalisation of just $170m, that equates to a free cash flow yield of about 18%.

Dividends announced

Last week's annual meeting confirmed the financial strength of the business with the company announcing an aggressive new dividend policy.

PMP will now aim to distribute 100% of net profit to shareholders – at least 75% of that will be via a dividend, which suggests that, at current prices, the business will pay a yield of 6%, unfranked.  The company also plans to buy back about $6m worth of shares.

That payout ratio may sound excessive but it equates to just 35-40% of free cash flow so this isn't another example of an Australian business paying dividends it can't afford. The yield is sustainable and leaves the business with cash to pursue other growth options.

It's important to note that statutory profits understate the profitability of PMP because the company depreciates about $30m worth of assets each year but spends just a fraction of that on capital expenditure.

Usually, this would arouse suspicion but, in this case, the divergence reflects the depreciation of an asset base that will not be replicated so maintenance remains lower than depreciation, allowing free cash flow to comfortably exceed profit. The business reported net profits of $8m but free cash flow of $28m last year. We expect this divergence to continue.

Books are back

Perhaps the biggest surprise came from the fledgling Griffen Press, Australia's largest book printing business, which recorded a 13% rise in revenue. The rapid growth of ebooks appears to have stalled, with printed books now gaining market share again in all categories, according to management.

The industry has also changed from printing single large print runs – often in cheap overseas markets – to smaller on-demand print runs. Business that had disappeared offshore is being forced to return locally.

The core catalogues business continues to perform well with more customers buying more services with PMP and unprofitable contracts rolling off without renewal. Competition for the few large accounts – desperately sought after to keep utilisation rates high – remains intense and the industry still suffers from overcapacity. Conditions, however, are improving and several smaller printers have gone bust.

Conversations with management suggest they are receptive to acquiring competitors but are unwilling to overpay to do so.

Our favoured outcome – PMP buying a competitor – will take time to engineer but the share price remains cheap enough to make the investment case worthwhile. We think the current business is worth at least 70 cents a share but a decent acquisition could lift that sum to $1. With an attractive valuation, a clean balance sheet and a stable business, PMP remains a SPECULATIVE BUY.

Disclosure: The author owns shares in PMP.