4imprint Group — Boxing clever

The customer landscape is looked at in the section below, but it is easy to overlook the importance of the supplier relationships in the business model. 4imprint guards its corporate integrity closely and this extends to its supply chain. Ethical standards on employment and sourcing back through the chain are high and the potential reputational impact of any lowering or breach of these standards on either 4imprint or its clients is considerable.

Just as there is ongoing consolidation within the distributors, there is a mirroring process happening within the supply base, with the bigger suppliers getting bigger and private equity funding moving into the sector.

As 4imprint’s business has scaled up, it has had to manage these supplier relationships in order to continue to meet customer expectations on quality and the expedited delivery schedules. This has necessitated gravitating to suppliers also of greater scale, where key factors, such as regulatory requirements, product safety and documented provenance, are easier to manage.

The group’s general approach is that of partnership. Given its industry positioning as market leader, it will tend to be the supplier’s largest customer, but it also endeavours to be a favoured customer through good communication and prompt payment. There is a natural limit on supplier concentration, given the sheer number of SKUs being offered across the various catalogues and online. Management estimates that the 10 largest suppliers account for around half of the overall group volume. Roughly one-third (and growing) of the total supplier base is supplying multiple product lines, a further third are supplying apparel and the balance have a particular product speciality.

There is a core team of senior merchandisers negotiating the larger contracts and conducting social/compliance audits, with around 25 further team members in support. Goods are designed and produced overseas and shipped to the US for decoration or else sourced domestically. For apparel, it was the growing scale of the operation that drove the decision to in-house the embroidery process.

Supplier prices are normally published and set on an annual basis.

The latest US government statistics show that there were just below 6m enterprises employing 500 or fewer staff in 2016, of which the overwhelming majority employ fewer than 20. There were 629k enterprises that employed between 20 and 500 workers. 4imprint identifies its target customer base as those employing more than 10 people and generating over $1m in revenue, so this measure is a reasonable proxy. The split by business sector is shown below.

The size of the US promotional products market is estimated at $23bn by the PPAI ($25bn including Canada). Management estimates that around one-third of the total market is accounted for by corporate programmes, ie contractual relationships with large corporations. Given the overall scale of the promotional products sector, 4imprint is able to afford to sidestep this corporate programme segment of the market, which would be significantly more capital intensive and contractual in nature. This leaves around two-thirds of the market truly addressable, allowing for considerable further growth before any market share constraints might emerge.

The PPAI statistics show apparel is the largest category of promotional products, at 28.8% of industry sales (increasing to 35.8% if accessories are included), followed by drinkware at 8.4%, writing at 6.6% and bags at 6.3%. 4imprint’s largest categories are shown above in Exhibit 1 and follow a broadly similar pattern. However, apparel is a more recent addition to the mix, building over the last five years, and we assume that it is still relatively underweight.

This is a competitive landscape, but the participants are predominantly small and locally active. Over the last few years, 4imprint’s growth has moved it up the relative ‘league table’ and it now has the largest sales of all US promotional product distributors. However, it still accounts for below 3% of the estimated market.

The second placed firm is Staples Promotional Products, based on the PPAI estimates (Staples is privately owned). The difficulty in measuring here is that promotional goods are sold alongside other office products. Unlike 4imprint, Staples is particularly heavily weighted to corporate programmes. Its FY17 revenues were estimated at $593m, versus 4imprint at $608m.

Halo Branded Solutions is also among the larger players (FY17 sales of $416m) and has also been expanding, but has a markedly different business model, being based on regional field salesforces travelling around the client pool. It has been adding smaller groups, often putting product categories in front of clients that those clients might not otherwise have considered. Proforma (FY17 sales: $369m) has a franchise-based business model based on printing, design and brand promotion, while BDA (FY sales: $347m) has a strong franchise in licensed sports affiliated merchandise.

Altitude Group is not considered a direct competitor as it is a SaaS and platform business within the sector, as opposed to a distributor.

Amazon has more recently been cited as a potential threat to the business model. While Amazon is underestimated at any competitor’s peril, we do not believe that a significant proportion of this type of trade will be transferring. As explained above, 4imprint’s operation involves a meaningful amount of interaction with the client to make sure that the design and specification are as required. For distributors selling through the Amazon Marketplace, the commission charged can vary from 15–25% of the sale price. As volumes are modest, due to the personalisation, this proposition is not likely to be that attractive to the core supplier base.

CEO Kevin Lyons-Tarr has been with the business since 1991 and is based in Oshkosh, Wisconsin. He has performed a number of roles within the group, including being CIO and COO, and become president of the Direct Marketing business in 2004. He was appointed as an executive director in 2012 and then CEO in March 2015. David Seekings, the group CFO (KPMG-trained), is also a long-standing employee, having joined as group financial controller in 1996. He moved from the UK to Oshkosh in 2000 to take up the role of CFO of 4imprint Direct Marketing and was appointed overall group CFO in March 2015, remaining in the US. They are both based (physically) at the centre of the principal office in Oshkosh from where the direct marketing is carried out.

For a company operating on a ‘mature’ basis, we would normally assess the valuation relative to other quoted businesses with similar operating models. We would then sense check this valuation via a discounted cash flow analysis. The issue for 4imprint is that there are not any genuine peers to measure it against. For context, therefore, we have looked at the multiples of other smaller/medium marketing services companies and at those of a smaller group of US B2B distributors, albeit that they operate in different market segments with greatly differing dynamics.

The UK small- and mid-cap marketing services groups self-evidently have business models substantially different from 4imprint and none have anything like the consistent performance record. They are nevertheless listed in the same sector and provide a particular backdrop.

4imprint is trading at a premium to these companies, which is to be expected given the financial record, strong balance sheet, high levels of cash conversion and potential for further growth. The lower EBITDA margin for 4imprint is simply a reflection of its different business model, with those peers shown in the table being primarily ‘people’ businesses.

Again, we provide this comparison with more than a degree of caution, given the disparity in the nature of their operations. The three we have picked out have some relevancy: Veritiv as it supplies B2B print, publishing and packaging services; Essendant, which is in the B2B supply and distribution of workplace products; and Core-Mark Holdings, which distributes and markets consumer goods.

The P/E multiples here are unreliable due to the volatility of underlying earnings and we would expect EBITDA to be a better reflection of the progression. Again, 4imprint trades at a premium on EV/EBITDA, albeit more modest and at least in part reflecting the higher levels of margin.

Given the issues with the peer-based approach and given the group’s financial characteristics – in particular the element of repeat business, the $1bn revenue target for FY22 and the management towards a maintained operating margin – the use of a DCF is more justifiable than is often the case.

We often look at a reverse DCF technique, where we vary the medium-term growth rate and the EBITDA margin, but in this instance there is designed to be little variation to the latter, which inclines us to using a more traditional approach. In Exhibit 10, below, we show a range of terminal growth rates and WACCs.

Using a WACC of 9% and a terminal growth rate of 3%, the DCF indicates a valuation of £22.87, 14% above the current share price. We used a WACC of 9.5% in our November note, with the same terminal growth rate, generating a valuation of £21.20. However, it is worth noting that this DCF is based on forecasts unadjusted for the better-than-expected trading update.

As indicated above, the trading update gives FY18 revenues at $738.4m, 2% ahead of our forecast of $725.0m. The guidance of PBT to “at least the upper end of the range of current market forecasts” suggests an outcome of a minimum of $45.5m, or $45.0m on a post share-based payments basis. This is around 1% higher than we had projected, continuing an established record of positive trading announcements.

The indicated net cash figure of $27.5m is also ahead of our modelled $25.0m, but this could be due to timing elements in working capital or taxation payments.

We will formally update our model on the publication of the full FY18 results, scheduled for 5 March.

4imprint now has a long record of consistent top-line growth, which is set to continue over the forecast period. Moreover, this is organic growth through a growing market and through gains in market share, rather than as the result of any acquisition programme. With no realistic candidates in the market, our forecast assumptions are also for straightforward organic growth in the same mould.

Management has publicly set the target of reaching revenue of $1bn by FY22. Achieving this will require a top-line CAGR of 9.8% for FY17–22e. If the FY18 revenue figure is in line with our estimate, the CAGR for FY18–22e comes in to 8.4%, which looks eminently achievable in the context of the growth record as shown above.

The group’s gross profit margin varies little, staying in a tight range of 32–35% over the last 10 years and steadying at 33% for the last five. We have modelled it continuing at this rate, although there may be slight variations according to mix. Below that line there is an element of comparatively fixed cost, covering off administration, central/listing costs (4.3% of FY17 revenue, 4.1% of FY16) and selling costs (4% of FY17 revenue, 4.6% of FY16).

The key variable element of the income statement is the marketing cost. Historically the business has been run managing that marketing spend in order to grow the top line while maintaining the operating margin. FY18 has seen a modest step away from that model in order to fund the brand marketing campaign on TV and radio, designed to boost awareness of the 4imprint brand. This has used a supplementary $7m on top of the ‘normal’ marketing spend of around $120m (17.6% of revenue was spent in FY17, 17.3% in FY16). We would expect management to say more about its plans for FY19 and future marketing priorities with the full FY18 results in March. We have shown the EBITDA margin in Exhibit 12, above, which shows it in the 6.7–7.2% range from FY11–17, dipping to 6.6% in our modelled FY18 figures, then reverting to 6.9%. The CAGR in group EPS is impressive, running at 19% for FY13–18e. Our forecast earnings growth for FY17–20e is 13.5%.

4imprint has proactively addressed its historical pension issues over the period since FY12, making larger contributions in FY12, FY14 and FY16. Obligations peaked in the balance sheet in FY12 at just short of $37m. The payments have now settled at the $3.6–3.7m per annum level, with defined benefit administration charges of $0.3m pa and an annual net pension finance charge of around $0.5m.

From FY18, the group is benefiting from the reductions in US corporation tax, with the expected rate now 20–21%, from recent periods in the high 20s%.

The tariff situation in the US is currently that a 10% tariff on certain categories of imported goods is levied. This was introduced in September 2018 and has largely been absorbed along the supply chain. The Trump administration’s intention was to lift the rate to 25% from 1 January 2019. This has now been shifted out to 2 March 2019 while trade talks between the US and China are ongoing. Management does not anticipate any significant short-term impact from the tariff imposition going ahead, as pricing for the year is already agreed and suppliers are working off existing inventory. The work needed to be done in those supplier negotiations and on internal systems is already in place. The partnership approach taken with suppliers should put 4imprint in a good position if any shortages occur. Replacing imports with locally produced items is unlikely to be possible due to volumes and comparative cost. If the trade war were to escalate, then the potential impact on the US economy would be a bigger issue in our projections.

4imprint has high inherent cash conversion, with the cash generated over the period from FY11 through FY17 shown below, along with the uses made of that cash. The conversion of operating profit to free cash flow (pre-tax) over the same period was 103%.

The group has no need for substantial infrastructure capex to grow its volumes, since, as explained above, it is not manufacturing product, albeit that there is product enhancement in the embroidery activity. With the growing emphasis on this aspect in response to client demand and with the larger scale of the business, a major expansion programme for the distribution centre was carried through in FY15 at a cost of $9m (brought in on time and on budget). This was done with a view to adding sufficient capacity to meet anticipated growth for a five-year period. The strong trading over recent periods has shrunk that timescale and the recent update outlined a further $5.0m spend on expanding the distribution centre, as described above.

Working capital requirements will only rise minimally, with very little stock held. Given that there is prevalence for customers to pay on credit cards, with credit-checking an integral part of the customer on-boarding process, there is little exposure to bad or doubtful debts.

As mentioned above, the requirement to fund pension contributions is now predictable and manageable, alongside the administration and pension finance charges. The group purchases shares for the EBT in order to meet the requirements of the SAYE scheme and of management share options.

The payout in ordinary dividends averages just below 50% over the last five years. A supplementary dividend was paid for FY17 of US$0.60, on top of the regular dividend for the year of $0.581. This was in light of the net cash on the year-end balance sheet reaching over $30m.

With the FY17 results, management clearly laid out its principles of capital allocation for FY18 and beyond. These comprise:

With debtors and creditors running broadly equal, and little in the way of stock on the balance sheet, the key features are the pension deficit and the cash. The former is now stabilised and reducing at $3.0m per annum. Given the strong cash conversion described above, the cash position on the balance sheet continues to strengthen. Management has set out balance sheet funding guidelines, which specify that the group should run a cash-positive balance sufficient to cover: the cost of the expected core dividend payments for the next year; known pension commitments; and known capital or investment spending requirements. Any significant surplus over these requirements may be available for supplementary distribution to shareholders.