PMP's merger blues
Recommendation
The Australian print industry has undergone a dramatic consolidation. Five fierce competitors, all armed with fixed costs and battling overcapacity and falling prices, have consolidated into two: PMP and IVE Group.
This is the industry consolidation we have been waiting for – the event that underpinned our earliest entry into PMP.
Our investment case rests on such a consolidation allowing industry capacity to fall and utilisation rates to rise. Prices – relentlessly lower over the past few years – would finally recover and margins would expand.
Key Points
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Merger benefits slow to emerge
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Competitor doing better
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Operating issues can be fixed
That investment case has worked out beautifully. In the new print duopoly, we are seeing lower capacity, higher utilisation, higher margins, and higher profits.
Unfortunately for us, these factors have so far been limited to IVE Group, rather than PMP.
Below par
PMP's results were poor and well flagged before the release. The numbers don't appear disastrous but certainly don't reflect high expectations following the merger.
Six months to Dec | 2018 | 2017 | /(–) (%) |
||
---|---|---|---|---|---|
Revenue ($m) | 402 | 264 | 52 | ||
EBITDA($m) | 20.2 | 11.1 | 82 | ||
Op cash flow ($m) | (12.9) |
|
n/a | ||
Net debt ($m) | 32.8 |
|
235 |
We were particularly disappointed with earnings before interest, tax, depreciation and amortisation (EBITDA) and free cash flow. We had expected a speedier path to higher margins and, while they were a little higher, they fell well short of expectations.
Free cash flow has been a highlight of PMP's performance for several years but disappointed as working capital requirements ballooned.
This appears to be related to merger activity and provisioning for lease exits, layoffs and asset retirements. We will watch the cash flow statement carefully in the next result.
Double bogey
So PMP has botched its integration of IPMG, the former industry number two; that its remaining competitor has been able to enjoy the benefits has rubbed salt into the wounds.
IVE has succeeded by closing three print facilities and moving additional work to assets with idle capacity. One print facility reported 25% higher volumes which, in a fixed cost business, can transform outcomes.
PMP hasn't made those same gains. While some capacity has been shut, the business hasn't made the same transformational efficiency gains.
Some of this has to do with the ACCC delaying the merger, which meant that the consolidation was undertaken during a traditionally busy period. And it has also been tough to reconcile the product mix of the two businesses with the asset mix.
Our disappointment has been shared by the market, which has punished PMP's share price. Where to from here?
We need to decide whether PMP's failure is a temporary setback or a permanent one.
The fact that one of the consolidators appears to be making hay suggests that an improved industry structure is indeed leading to better financial outcomes. IVE has integrated better and also has a head start, having consolidated sooner.
We all know this is a lousy business in a lousy industry but, if IVE is any guide, poor quality doesn't appear to be an insurmountable obstacle to better performance.
We hear that the industry is beginning to see some price rises. Customers are seeking instant renewals, hoping to avoid higher prices, without going to tender, signaling a definitive shift in the balance of power.
We are aware of several large contracts that already accommodate higher prices. The path ahead is clear, PMP needs now to get the details right.
The way back
PMP has made operating mistakes and done a bad job of combining the two businesses. Digesting a large acquisition can be difficult.
Unlike Vocus, for example, this isn't a complex integration that requires back-end software compatibility and different asset mixes to be stitched together.
PMP and IPMG both run big printers. They need to shut some of those printers and improve utlisation at other sites. Management then needs to negotiate price rises.
That combination – higher utilisation and higher prices – will propel profits higher and shouldn't involve insurmountable challenges. In short, we think PMP can still right the ship and enjoy significant merger benefits.
A lot will now depend on management. Former chief executive Peter George left abruptly after a death in the family and a new CEO has come from IPMG with years of experience. The Hannan family owns a third of PMP's stock and has the experience and incentive to get this right.
Happy ending?
This has been a frustrating few months at PMP, a period that has included jubilation and disappointment. The story isn't over yet. The business has plenty of work ahead of it but, at these prices and with new management at the helm, we think the odds of success are good enough to warrant hanging on.
With a forward enterprise value to EBITDA multiple of less than four and a potential free cash flow yield over 20%, this remains alluringly cheap, albeit low quality.
We've travelled a long road with PMP, long enough to see operating improvements, financial improvements and industry improvements. The final hurdle is now to execute and take advantage of the better conditions. We're reintroducing a price guide with a Speculative Buy below 25 cents and a Sell above 50 cents. HOLD.
Note: The Intelligent Investor Equity Income Portfolio owns shares in PMP. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: The author owns shares in PMP.