Pitney Bowes: Will This Fallen Aristocrat Rise Again?

Founded close to 100 years ago, Pitney Bowes (PBI) has, for most of its existence, sold postage meters and provided mailing services. It was a steady and profitable business, and over the years, Pitney Bowes grew to become one of the largest mailing companies. It even managed to become a Dividend Aristocrat, marking its 25th year of consecutive dividend increases in 2007. Alas, times change, and the rise of electronic communications led to the decline of mail volumes and business faltered. The dividend was slashed in 2013, and the company embarked on a quest to transform itself into a shipping company to ride the tide of e-commerce. Relying on the cash flows of a declining, but not quite dead mailing business, the company has built up a respectable, if not quite yet profitable, shipping business through a combination of organic growth and acquisitions (Borderfree in 2015 and Newgistics in 2017). Through it all, earnings have steadily declined, and the stock has followed a remarkably linear path towards zero.

PBI Fastgraphs

Source: Fastgraphs

Now, as things are looking bleakest, the shipping business is finally on the cusp of profitability, and the hemorrhaging of the mailing business appears to have finally been staunched. Is Pitney Bowes finally ready to turn the corner, or is this just another step towards oblivion? Pitney Bowes recently held an Investor Day. Let’s take a look at what’s going on at the company.

Small & Medium Business solutions

SMB has long been the crown jewel at Pitney Bowes, producing the lion’s share of EBITDA at outstanding margins in the mid-30 percentile range. The problem is that it has been in long-term decline due to decreasing mail volumes. The recent move into shipping has somewhat mitigated the loss of revenue from mail, and management expects that continued growth in shipping will eventually offset the decline in mail to produce flat or positive EBIT by 2021.

A couple new products were announced during the Investor Day presentation. First is the SendPro Tablet, which is not particularly groundbreaking, but at least keeping up with the current state of technology. Key features include camera-based address capture, voice activated commands, and ability to connect wirelessly to weighing scales and label printers. Second is SendPro Insights, a data analytics package which breaks down mailing and shipping usage and costs and provides recommendations.

Beyond the core activities of shipping and mailing, management also highlighted several areas of potential growth: 3rd party financing (discussed below), apps, and partner ecosystems. An example given was the case of Deliv, a crowdsourced same-day delivery service which partnered with Pitney to produce an app for the SendPro ecosystem to allow printing of labels for its service. Pitney, in turn, gains Deliv as a carrier option alongside more traditional services such as FedEx (NYSE:FDX), UPS (NYSE:UPS), and USPS, providing more options for their clients.

Financial Services

The financial services division enables more than 80% of the shipping and mailing activity at Pitney Bowes, primarily through leases of postage meters. As can be expected, with the decline in mailing, finance receivables have been steadily declining over the past few years. Although the decline appears to have stabilized in recent quarters (most recently -2% year over year), this is expected to continue with the decline in mailing. The new initiative to restore growth is the creation of Wheeler Financial, which offers to finance 3rd party equipment deemed critical to business as seen in the slide below.

The opportunity here is in small and medium businesses, which lack access to capital from banks which have focused more on large corporate loans. The collapse of GE Capital has also taken significant money out of the space. Pitney Bowes has several advantages in this market: low customer acquisition costs due to an established customer base (over 750k customers), experienced customer relationships (average 8-10 years, with insights on credit trends), and low cost capital ($350M excess deposits at Pitney Bowes Bank). The initial plan is to originate $50-70M in 2019 with further scaling in the years to come.

The equipment financing business appears to be lucrative and relatively safe, considering how the collateral assets are essential to continued operations of the customer, but one has to wonder why so few other financial institutions have stepped into this market. Furthermore, signs are pointing to this being close to the top of the business cycle, and the timing of this new venture is questionable. The opportunity for growth is compelling, but it is difficult to evaluate the additional risk taken.

Software and Data solutions

This segment, while growing, does not seem to be a primary focus for Pitney Bowes. Comprising 10% of total revenues, the goal of this segment appears to be monetization of Pitney’s location data. With mid single digit growth expected over the next few years, data will continue to be a small but steady contributor to Pitney’s top and bottom lines.

Commerce Services

The star of the show, Pitney’s turnaround plans are based largely around continued growth of this segment. Guidance for this segment is that it should be EBIT profitable in 2020 (compared to current 3% EBITDA, -3% EBIT margins). The chart below shows the growth of revenue for this segment.

PBI Commerce Services Revenue History

The major jump in revenue at the end of 2017 was due to the acquisition of Newgistics. Excluding that one time event, revenues for the Global Ecommerce division have been growing at low double-digit rates annually. It should also be noted that the timing of shipping revenue follows the trend seen in many retailers: heavily weighted in 4th quarter due to holiday sales.

Perhaps more convincing, the total client base has been increasing dramatically. In the last year, over 250 clients were added, bringing total customer relationships to over 800, including brands such as these:

This pace of growth is expected to continue, with churn in the low single digits.

A key facet of Pitney’s ability to gain and retain clients is their focus on customer relationships. Pitney Bowes focuses on enabling and enhancing customer brands. Examples include custom branded packaging, branded tracking, and marketing on behalf of customers, which allows Pitney’s clients to continue engaging with their customers even after a sale. An example given was the newly launched Consumer Connect, which provides a branded tracking experience which can be easily customized with promotions, social media links, and other forms of customer engagement. Given that Pitney’s data shows a package is tracked on average 8 times, it is easy to see the value proposition for clients, especially when contrasted with carriers which only provide tracking information on their own sites.

Also newly launching is a 3-Day Guaranteed Delivery service. While this is still a far cry from 1 or 2 day deliveries from services such as Amazon Prime, according to Pitney’s customer surveys, 3 days is generally “good enough” for most customers. Contrasted with the current standard 5-day delivery service, this new offering should allow Pitney to gain and retain more clients.

At this point in time, the Global Ecommerce platform is still scaling. In comparison to the Presort Services, which is considered fully scaled with 38 operating centers, Global Ecommerce currently has 14 operating centers (5 new facilities added since the acquisition of Newgistics). To gain scale, Pitney will need to continue expanding their network and growing volumes. Based on current projections, Global Ecommerce will be “at scale” exiting 2022 with annual volumes of 250 million parcels (currently 110 million).

Debt

Pitney Bowes does have a relatively large amount of debt, with significant maturities in the next few years. During the Investor Day presentation, the CFO indicated that the company intends to refinance and additionally create warehouse capacity for the newly launched Wheeler Financial. Given the deterioration in company financials and credit ratings (Moody’s recently downgraded from Ba1-Negative to Ba2-Stable; S&P BB+) and the company’s buyback plan skewing debt to equity ratios, it is safe to say higher interest expenses are ahead.

PBI Debt Maturity

Total company debt stands at $3.3B, of which $1.1B is related to the financing business. Excluding this, implied operating company debt is at $2.2B with cash and short-term investments of $0.9B for net debt of $1.3B. Full year 2018 adjusted EBITDA was $442M, implying a leverage ratio of 2.94X. On the other hand, Moody’s calculates adjusted leverage at 4.4X. Interest coverage is currently approximately 3X, but may decrease with refinancing.

The Big Picture

Pitney Bowes appears to be slowly, but surely, transforming itself from a stodgy old mailing company to a tech-savvy shipping company. All of its operating segments appear to be stabilizing or showing signs of growth, at least in revenue. The bottom line, however, continues to be pressured due to continued investments and unforeseen events. Looking to the future, this is how Pitney Bowes envisions itself in 3 years:

PBI Long Term Financial Model

With Global Ecommerce expected to become profitable in 2020 and SMB to switch to growth by 2021, 2019 may very well be the trough year for earnings. However, given the continued investments in building out the network and growing Wheeler Financial, free cash flow will continue to be pressured until 2022.

The most recent guidance from management calls for 1-3% revenue growth, EPS in the range of $0.90-1.05, and free cash flow in the range of $200-250M for 2019.

Analyst ratings are slightly bullish, with average price targets in the $7-8 range. Forward earnings are estimated at $0.91 for 2019 and $0.94 for 2020.

Risks

Before you go out and buy shares of Pitney Bowes, it is wise to evaluate the risks of owning this company. At first glance, it appears very undervalued, at under 5 times forward earnings. But you must recall that earnings have been steadily declining for quite some time, and only a few months ago, this year’s guidance was slashed due to poor performance in the first quarter. Many analysts and authors before me have tried to call the bottom and failed miserably. Here are the major risks I see for this company.

Slow/Poor Execution

If slow and steady wins the race, then Pitney Bowes is an old tortoise with arthritis, stopping to smell the flowers and take a nap every few steps. The market rewards results, preferably quick results, and while Pitney Bowes does have some results, they have been incredibly slow at getting them. The current CEO, Marc Lautenbach, joined Pitney Bowes at the end of 2012, tasked with turning around the company. After a short-lived bounce, the stock has gone nowhere but down. To be fair, transformation of a company at this scale is difficult and requires time, but investors are an impatient lot, and this seems a little excessive, and the company is running out of time. Going forward, it is imperative to see continued growth in the shipping business. The Wheeler Financial initiative, while interesting, adds significant risk and may distract from the needed focus on Commerce Services.

Recession

Several yield curves have inverted and interest rate cuts may be on the horizon. Many factors are pointing towards the end of the business cycle. If the economy slips into recession, Pitney Bowes will be greatly impacted as their business is highly dependent on economic activity.

International Affairs

The trade dispute with China (and other countries) adds significant risk to Pitney’s business. Earnings guidance was already slashed once to account for the 10% tariffs. If the 25% tariffs remain in effect for a prolonged period, earnings will likely take another hit. On the other side of the world, Brexit continues to create significant confusion with regards to the future of trade in Europe.

Leverage

As mentioned previously, Pitney Bowes is heading towards refinancing, at the highest interest rates we have seen in a while, with a less than stellar balance sheet and uncertainty with regards towards future earnings. Default does not seem likely at this point, but risk is certainly elevated.

Other Considerations

Amazon

For years, Amazon (AMZN) has been shifting away from being solely a marketplace for sellers, instead becoming a retailer itself. This is most evident in the increased offerings of products under private label brands such as Amazon Basic, which compete directly with third party offerings on Amazon and receive preferential placement in search results. In recent news, there is speculation Amazon is considering cutting out smaller wholesalers, instead focusing on larger brands. As a result, alienated sellers are becoming more dependent on their own brands and websites to drive sales, rather than relying on the Amazon ecosystem. Smaller businesses may choose to stop relying on Amazon’s distribution network and instead fulfill their orders using the national carriers or USPS. This presents a market opportunity for Pitney Bowes to offer shipping solutions and other value added services.

Stamps.com

The recent review of Negotiated Service Agreements (NSAs) by the Postal Regulatory Commission has led to major changes in the landscape of domestic shipping solutions. Most notably, the NSA with Stamps.com (STMP) was canceled, and in its most recent earnings call, Stamps.com further warned that NSAs of many of its reseller partners were also under review and would likely result in decreased margins. This will result in increased costs for many shipping companies. In fact, in Pitney’s own first quarter results, a delayed approval of an NSA contributed to increased shipping costs and underperforming earnings. A key point, however, is that Pitney’s NSA was renewed on substantially the same terms as its previous arrangement. Here, the major difference between Pitney Bowes and companies such as Stamps.com is that Pitney actually has a logistics network and contributes to the delivery of packages, rather than just printing shipping labels. As such, Pitney’s arrangement with the USPS is mutually beneficial and likely to be continued in the long term. Given the recent changes to NSAs, it is likely that higher costs at other companies may result in increased prices and cause churn, resulting in an opportunity for Pitney Bowes to gain market share.

Insider Buying

There have been a few modest insider buys recently:

PBI Insider Transactions

Source: Openinsider

Buyback

$61M remains of the $100M buyback announced for this year. At current prices around $4, that could retire approximately 15M shares – about 8% of shares outstanding.

Dividend

After the most recent slide, Pitney Bowes yields close to 5%, even after the dividend cut (the money was redirected toward buybacks, but it is unclear if this will continue to be the case in following years). This appears to be sustainable as the $36M annual commitment represents less than 20% of free cash flow.

Short Interest

Short interest has been increasing, with over 30M shares sold short as of May 14, 2019. This represents 17% of shares outstanding, and, based on average daily volume, would take 7.5 days to cover.

Conclusion

Pitney Bowes seems to be a compelling value play at less than 5X forward earnings and 4X free cash flow. The business has been in decline for years, but there are some signs that growth is returning to the company. Unfortunately, this is currently only reflected in revenue as profit margins continue to shrink due to continued investment. It will likely be another year or two before earnings begin to pick up. In the meantime, risks abound due to leverage and the economic environment. It may be appropriate to begin building a position as the business appears to have stabilized. However, until the company is able to report increased earnings, there is no clear catalyst to break it out of its 5-year downtrend.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PBI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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