Digital Payments Shift And Data Margins Will Support A Fairly Valued Outlook

Catalysts

About Deluxe

Deluxe provides payments, data-driven marketing, B2B payment solutions and print products to financial institutions and business customers.

What are the underlying business or industry changes driving this perspective?

• Although payments and data already represent 47% of revenue and management expects revenue parity with print, the ongoing industry shift from paper-based transactions to digital could pressure legacy print volumes faster than newer offerings can scale, which may cap consolidated revenue growth and limit EPS expansion.
• While Deluxe is using a large consumer and small business data lake and Gen AI tools across thousands of campaigns, rising competition from larger data and marketing platforms could compress pricing on campaigns and vendor rebates, which would weigh on Data segment margins and overall EBITDA margin.
• Even with DMS integrating Visa Direct through Deluxe Fast Funds and investing in APIs and embedded solutions for ISV partners, adoption curves for new payment rails can be lengthy and partner onboarding can slip, which may hold Merchant Services revenue growth to mid single digits and moderate any margin gains from the ISO residual buyout.
• Despite ongoing migration of B2B Payments toward more recurring digital offerings and DPN capabilities, customers may move more slowly to electronic payables and lockbox alternatives than planned, which could keep B2B revenue in the low single digit range and limit further EBITDA margin expansion beyond the low to mid 20s profile.
• Although Deluxe reduced net debt to US$1.39b and targets a leverage ratio of 3x or lower, continued investment needs in AI, data infrastructure and payments platforms, alongside secular print declines, could constrain free cash flow growth above the guided US$200m level and temper improvements in net margins and adjusted EPS.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Deluxe compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Deluxe's revenue will decrease by 3.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 4.9% today to 8.8% in 3 years time.
• The bearish analysts expect earnings to reach $169.5 million (and earnings per share of $3.47) by about June 2029, up from $103.9 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $215.6 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 11.4x on those 2029 earnings, up from 10.5x today. This future PE is lower than the current PE for the US Commercial Services industry at 22.1x.
• The bearish analysts expect the number of shares outstanding to grow by 2.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.68%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Payments and data already account for 47% of revenue and management is aiming for parity with print, so if these newer segments keep gaining share and maintaining the 10% full year growth rate they recently reported, total revenue could trend higher rather than flat, which would likely support earnings and net margins.
• The Data segment recently reported 31.3% revenue growth with adjusted EBITDA margin at 28.1%, supported by a large data lake and Gen AI tools. If this high margin business continues to scale, consolidated EBITDA margin and EPS could rise more meaningfully than a flat share price view assumes.
• Merchant Services, B2B Payments and Data are guided to mid single digit, low single digit and mid to high single digit revenue growth respectively. If these growth profiles continue to offset low to mid single digit secular declines in Print, overall revenue and operating income could trend upward and put upward pressure on the share price.
• Management is targeting free cash flow of about US$200m after already delivering US$175.3m and reducing net debt to US$1.39b with a leverage ratio of 3.2x. Further deleveraging toward the 3x target and continued cash generation could improve equity value as interest costs ease and net margins benefit.
• Company wide EBITDA margin is currently 20.2% with margin expansion in all four segments and guidance for adjusted EBITDA to rise to US$445m to US$470m. If operating leverage and cost efficiencies remain on track, sustained growth in EBITDA and adjusted EPS could support a higher valuation multiple and share price.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Deluxe is $31.0, which represents up to two standard deviations below the consensus price target of $32.67. This valuation is based on what can be assumed as the expectations of Deluxe's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $35.0, and the most bearish reporting a price target of just $31.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $1.9 billion, earnings will come to $169.5 million, and it would be trading on a PE ratio of 11.4x, assuming you use a discount rate of 8.7%.
• Given the current share price of $23.93, the analyst price target of $31.0 is 22.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.