Unlocking EBITDA And Cash Flow Through Efficiency And Tactical Pivots

Key Takeaways

• Deluxe is focusing on operational efficiencies and a strategic pivot to high-margin segments like Merchant Services and Data Solutions for earnings growth.
  
• Transitioning B2B Payments to a SaaS model and efficient rebranding efforts are aimed at enhancing revenue predictability and operational effectiveness.
  
• Deluxe faces challenges from macroeconomic pressures, sectoral declines, and a shift to SaaS in B2B Payments, affecting revenue growth and margins despite new strategies.

Catalysts

Provides technology-enabled solutions to enterprises, small businesses, and financial institutions in the United States, Canada, and Australia.

• The North Star operating plan focuses on unlocking significant incremental adjusted EBITDA and annualized incremental free cash flow by 2026 through initiatives already partly executed, aiming at improving operational efficiencies and reducing corporate segment expense as a percentage of total company revenue. This operational improvement is expected to drive net margins and earnings growth.
  
• Emphasizing the Merchant Services and Data Solutions segments, which reported year-to-date growth rates of 13% and 8% respectively, suggests a strategic pivot towards these higher-margin, potentially faster-growing areas. This shift could impact future revenue streams positively and contribute to overall earnings stability and growth.
  
• Deluxe's commitment to transitioning the B2B Payments segment towards a recurring Software as a Service (SaaS) model, away from one-time nonrecurring revenues. This transition aims at increasing the segment's revenue stability and predictability, impacting future revenue and net margin positively by reducing reliance on variable, project-based income.
  
• Efforts in rebranding and consolidating brands, like the merger of the six brands into Deluxe Merchant Services, aim at improving marketing efficiency and performance. This streamlining could enhance overall operational efficiency and effectiveness, leading to cost savings and potentially higher margins.
  
• Deluxe's initiative to reduce net debt and improve the net debt-to-adjusted EBITDA ratio, reflecting diligent capital management, which is expected to enhance financial stability and flexibility. Improved capital allocation and debt reduction can lead to lower interest expenses, positively affecting net income and earnings per share (EPS).

Assumptions

• Analysts are assuming Deluxe's revenue will grow by 1.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.8% today to 5.3% in 3 years time.
• Analysts expect earnings to reach $118.6 million (and earnings per share of $3.12) by about October 2027, up from $38.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.4x on those 2027 earnings, down from 22.2x today. This future PE is lower than the current PE for the US Commercial Services industry at 26.6x.
• Analysts expect the number of shares outstanding to grow by 1.36% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 9.84%, as per the Simply Wall St company report.

Risks

• Deluxe's exposure to potential macroeconomic pressures such as consumer discretionary spending trends and interest rate environments could impact its Merchant Services and short-cycle promotional product segments, potentially leading to lower-than-expected revenue growth.
  
• The shift towards nondiscretionary spending observed in the Merchant segment may indicate a softening demand for discretionary services, which could affect revenue growth in this segment.
  
• Continued secular declines and expected softness in the B2B Payments and Print segments, despite some areas of strength, pose risks to overall top-line performance and may impact revenue and net margins negatively.
  
• Ongoing revenue headwinds and the transition to a SaaS model in the B2B Payments segment, coupled with base volume softness in lockbox services, could lead to lower than anticipated revenue and margins, despite efforts to offset declines with new client wins.
  
• The company's guidance adjustment due to lingering macro uncertainty over the balance of the year highlights potential risks to achieving forecasted financial outcomes, which could impact earnings and free cash flow projections.

Valuation

• The analysts have a consensus price target of $30.0 for Deluxe based on their expectations of its future earnings growth, profit margins and other risk factors. 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 $25.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.2 billion, earnings will come to $118.6 million, and it would be trading on a PE ratio of 15.4x, assuming you use a discount rate of 9.8%.
• Given the current share price of $19.15, the analyst's price target of $30.0 is 36.2% 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.