4imprint Group — Further progress in Q323

4imprint presents a unique investment case: a UK-listed company, with British and US management, run out of the US and with 98% of revenues generated in the US. It is a distributor of promotional products across the spectrum of enterprises in North America, with a large range of product across categories from pens to apparel. The market is very large (industry body Advertising Specialty Institute (ASI) estimates a value for distributors of $25.8bn in FY22, rebounding to the level last seen in FY19). It is also highly fragmented and 4imprint has the largest market share at just below 6%. It has achieved this prominence through organic growth, helped by its reputation for quality, reliability and customer service. There are no direct comparators, as the other large players have differentiated business models, described below. The model is very straightforward: direct marketing stimulates demand, met either by drop-shipping from suppliers or, for apparel, from the group’s main distribution centre in Oshkosh, Wisconsin. Sophisticated data-driven marketing is core, supplemented with brand awareness advertising that drives direct traffic to the website.

Recent weakness in the share price post the Q323 update has eroded the premium at which the group’s shares trade to other marketing service companies, but we regard them as a flawed proxy given the differentiation of the business models. In our discounted cash flow (DCF) we now apply a WACC of 9% to reflect the more uncertain economic background, but our other assumptions on margin, etc, are unchanged. This generates an implied valuation of £60.68, down from £68.20 in our August note at an 8% WACC.

4imprint’s core sensitivity is the health and confidence of the North American corporate economy. Its financial performance also depends on the continuing efficacy of its marketing efforts. The group takes its responsibilities towards its employees, customers and suppliers very seriously, which stands it in good stead in more difficult trading conditions. The products it supplies signify its customers’ brand values, with all the inherent reputational risks. More specific sensitivities include currency, as the group earns 98% of its revenues in US dollars but carries its head office costs, pension scheme commitments and pays its dividend in sterling. It reports in US dollars, so a stronger dollar has a positive impact and vice versa.

4imprint’s business model is remarkably straightforward. It supplies customised, promotional products to customers across North America (98% of revenues) and the UK and Ireland (2% of revenues). The company grew revenues steadily over many years to FY19, when the trajectory was interrupted by the COVID-19 lockdowns. These had a severe effect on demand as corporate America diverted its attention to managing the immediate impacts. Once those lockdowns eased, 4imprint bounced back strongly, exceeding its long-held strategic ambition to push through the $1bn revenue threshold in FY22, achieving $1.14bn in that year.

Management leads with a strong ethos of ‘doing the right thing’ by all its stakeholders: customers, suppliers, staff and shareholders. It is highly protective of the group’s reputation for ‘best-in-class’ customer service and of its partnership approach to dealing with its suppliers. In both aspects, the brand’s positioning undoubtedly helped to give a degree of resilience over the COVID-affected period and subsequent supply-side inefficiencies.

The scale of the operation is large, running at around 1.9m orders a year. All are individually customised and of great importance to the customer. The market is highly fragmented; there are reported to be over 30k distributor firms in North America alone, of which c 26k are in the US. It is, however, substantial, estimated by industry body ASI to have been worth $25.8bn in 2022. The overwhelming majority of these distributors are small, with fewer than 1k having revenues of more than $2.5m.

Orders are processed, customised, then despatched, mostly direct from the supplier (apparel being the major exception). The large distribution facility is in an industrial zone on the outskirts of Oshkosh, Wisconsin. Having been based in Oshkosh since the early 1990s, 4imprint is a well-established local employer and cultivates its reputation as a preferred employer through offering benefits such as training, onsite medical and dental provision (company-funded), holiday pay and pensions. Staff retention is very good, with turnover in low single digits, with the company’s reputation enhanced locally by the way it treated its staff during the pandemic.

4imprint’s typical client has over 25 employees and has revenues of over $1m and could be drawn from any part of the economy – commercial, academic, governmental, charitable or other – and there is no particular bias to any one or group of industries. The group’s growth has consistently outstripped the market, with an all-organic revenue CAGR of 10.6% for the period FY12–22, compared to an estimated market growth of 2.9%. This premium growth is delivered through the group’s sophisticated direct marketing operation, based on data and covering online and offline approaches to acquiring new customers and to drive return visits.

Promotional products are used by businesses to increase the profile of their services, products or events, and also to motivate staff within their own operations. The product range offered by 4imprint is extensive, from the basic, such as pens, bags and drinkware, through to higher priced items such as apparel, business gifts and full displays for trade shows. All are customised with the name and/or logo of the organisation doing the promotion. In FY22, 4imprint handled around 1.86m orders, up 30% on the prior year, with an average order value of over $600.

Apparel is a particularly important category in the industry and is an area where 4imprint had been under scale. It is inherently more complex to fulfil, with multiple sizing, colourways etc. Apparel has a particularly high perceived value and is often used as an element of staff motivation, in addition to its inherent promotional benefit. It obviously sells through at higher price points and boosts basket size. The embroidery side of 4imprint’s offering differs to its other products due to the degree of customisation that must be carried out before despatch. Management has evaluated the business and commercial dynamics of in-housing as opposed to external sourcing. The key issues swaying the argument to an internal solution principally surround scalability, product quality and speed. Unless these can all align, the risk to client satisfaction – and hence quality, repeat business – is too high. Bespoke digital printing is also carried out at the facility for display materials and where transfer printing is preferred or technically superior to embroidery for fabrics and bags. 4imprint has expanded its capacity here, adding three direct-to-garment printing machines.

A short video of some of the embroidery production is included below (Exhibit 4).

Over recent years, 4imprint has developed some brands of its own to infill certain product categories. While modest in terms of the overall percentage of sales, they allow for a greater degree of control, including on ethical sourcing and sustainability. There are currently three own brands in the stable:

4imprint is essentially an online business model. However, part of the strength of the business is the management of the combination of digital and analogue. This applies both to the marketing and the operational side, where day-to-day activities involve a far higher element of handholding for customers for whom this type of buying is not central to their normal working practices. Customer service personnel talk to customers over the phone to guide them through the process, from the main office in Oshkosh, Wisconsin, and remotely where appropriate.

At the end of December 2022, 4imprint employed 1,367 people, a workforce usually supplemented with temporary employees according to the demand cycle across the year. In FY22, 42% were employed in distribution and production roles, 41% in sales and marketing and the balance of 17% in administration.

Within the main office, there are some specialist teams: one focused on inbound enquiries from Canada, including French speakers; an education team, focused on K-12, colleges and universities, and on licensing; federal, state and local government; Spanish speakers; and a team specifically dealing with claims and credits. Supplier faults/errors and delivery issues are dealt with promptly by this team and the overall rate of orders needing attention of this type runs at less than 2%.

4imprint has many years of experience honing what does and does not work when it comes to encouraging existing customers to buy and how to acquire new customers. Management monitors marketing effectiveness through key performance indicators (KPIs) such as the number of customers acquired, and the percentage of those customers retained after 12 and after 24 months. The long-term trends for these metrics are shown in the exhibit below, which clearly shows the degree of disruption prompted by the pandemic.

The group uses a wide range of marketing techniques, including a small residual element of ‘traditional’ printed catalogues, search engine marketing, email, quantitative analytics, Blue Box physical samples (used for customer retention) and, more recently, television-based campaigns aimed at boosting brand awareness. Photographic work is carried out in studios at the head office, with models all drawn from the workforce. This has obvious cost benefits but also adds to the authenticity of the branding.

The management of the marketing mix is sophisticated and is based on the data derived from each marketing exercise, which is fed back into the planning. This systemic management of the marketing effort is a vital part of the group’s IP and is key to how the group has been able to build its market share through understanding customers’ needs and buying patterns. This has been even more crucial over the last two years, when flexibility and speed of response have been paramount.

It is the introduction of brand marketing to the mix that been the most revelatory, delivering a step change in productivity and hence operating margin. The first linear TV brand campaign was launched in FY18 and immediately outperformed initial expectations, delivering high volumes of organic traffic to the group’s website and increasing unprompted brand awareness. Now that the main disruption over COVID-19 has passed, it is clearer how this shows through in the step up in revenue per marketing dollar, which is one of the group’s main KPIs.

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. 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. This attitude has stood the group in strong stead over recent periods, with complexities and delays with shipments from China and the intricacies of the logistics of distribution in North America. With constant evolution in product mix, open communication and trust are essential, and may be the crucial deciding factor on who to deal with. Being paid on time also helps considerably.

Just as there is ongoing consolidation within the distributors, there has been a mirroring process happening within the supply base, with the bigger suppliers getting bigger and private equity funding having moved into the sector. As 4imprint’s business has scaled, it has had to manage its supplier relationships to continue to meet customer expectations on quality and on 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.

There is a natural limit on supplier concentration, given the sheer number of SKUs being offered across the various catalogues and online. In general terms, 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 supplies multiple product lines, a further third is supplying apparel and the balance have a particular product speciality.

There is a core team of senior merchandisers negotiating larger contracts and conducting social and 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.

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

The size of the US promotional products market for FY22 was estimated at $25.8bn by the industry body ASI. This was an 11% increase on the year and matching levels seen in 2019, prior to the lockdowns.

Industry estimates suggest that around one-third of the total market is accounted for by corporate programmes, namely contractual relationships with large corporations. Given the overall scale of the promotional products sector, 4imprint can 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. Stripping out the corporate programmes increases 4imprint’s share of the addressable market, but there is obviously still plenty of potential for further growth.

This is a competitive landscape (industry body Promotional Products Association International (PPAI) estimates around 30k distributors), 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 in FY22 it had regained its position as having the largest sales of all US promotional product distributors, although in H123 it still only accounted for around 5.9% of the estimated market. The figures across the COVID-affected years were affected by the inclusion of some PPE products into the market (though not for 4imprint), which temporarily cost the group its top ranking.

The second largest distributor is HALO Branded Solutions (FY22 revenues: $1,000.7m, +22.5% year-on-year; owned by TPG Capital), which supplies branded merchandise, corporate apparel, uniform programmes, and recognition and incentive solutions to (often large) corporate customers. Third largest by sales was Staples Promotional Products (FY22 revenues: $888.2m, +20.0%; owned by private equity firm Sycamore Partners). Staples has a markedly different business model based on regional field salesforces travelling around the client pool. It is particularly heavily weighted to corporate programmes.

Custom Ink, with FY22 revenues of $800.0m, +22.6%, started out as a customised t-shirt business where people uploaded their own designs, and now has a substantial product offering. Proforma (FY22 sales: $620.0m, +14.6%) has a franchise-based business model based on printing, design and brand promotion. BDA (FY22 sales: $422.2m, +22.4%) has a strong franchise in licensed sports affiliated merchandise.

The Pebble Group is not considered a direct competitor, and neither is Altitude Group. The former provides technology solutions and a digital commerce platform to SME promotional product distributors and has a corporate programmes arm, while the latter is a SaaS and platform business within the sector, as opposed to a distributor.

Amazon has often been cited as a potential threat to 4imprint’s business model. While Amazon is underestimated at any competitor’s peril, we do not believe it will take a significant proportion of this type of trade. 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 CIO and COO, and became 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.

The key sensitivity for 4imprint and its peers is the health (or otherwise) of the economy, particularly that of corporate entities across North America. Its particular sweet spot is small and medium-sized commercial enterprises with between 20 and 500 employees. These firms are large enough to be considering marketing their organisations, but not so large as to have the capacity to source directly or be of sufficient scale to take out a corporate programme. As such, the normal economic cyclicality is limited, with some counter-cyclical elements as businesses may be more likely to drive differentiation and bolster their market positioning.

Other factors that may influence financial performance include:

For a long period, the group’s historical pension arrangements were material to the overall financial outcome. With the recent buyout (described in greater detail in the Financials section, below), this no longer represents a financial risk to 4imprint.

4imprint has considered its corporate responsibility as a key facet of its ethos long before ESG became more general practice. It has now formalised its approach. In particular:

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 DCF analysis. The issue for 4imprint is that there are not any genuine quoted peers to measure it against. For context, therefore, we have looked at the multiples of other smaller/medium-sized marketing services companies and those of a smaller group of US B2B distributors, although they operate in different market segments with greatly differing dynamics.

Marketing service groups context

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 has historically traded at a premium to these stocks, reflecting its financial record, strong balance sheet and high levels of cash conversion. 4imprint’s FY22 EBITDA margin of 9.5% is structurally lower than that of the marketing services companies at 11.7%, reflecting its different business model as a distributor. The premium to these stocks on current year P/E is 14%, which is well below historical levels of nearer 50%. As at the end of September, 4imprint’s shares were trading 12% below their long-term average FY1 EV/EBITDA (long-term being back to 2006 to smooth out cyclical and pandemic effects).

We have previously also looked at US-quoted distributors, but here the pool of relevant stocks is very limited, as are any elements of commonality. Veritiv, a full-service B2B provider of packaging and hygiene products, trades on an FY23 P/E of 8.4x and EV/EBITDA of 5.1x, whereas Fastenal, a distributor of industrial and construction products, trades at premium current year multiples of 30.4x and 20.5x.

DCF is a relevant valuation technique

Given the issues with the peer-based approach and given the group’s financial characteristics – particularly the element of repeat business – a DCF is our preferred valuation technique.

In Exhibit 10, below, we show a range of terminal growth rates and WACCs, predicated on the projections contained in the financial summary in Exhibit 13. Beyond the explicit forecast period, we assume revenue growth of 8%, which is below that achieved historically (FY13–22 CAGR 14.7%), although above the 4.9% we have modelled for FY24. Given the changed macroeconomic backdrop, we increase our WACC from 8% to 9% but retain our terminal growth rate assumption of 3%. We also assume EBITDA margins are stable over FY26–31 at 9.5% (slightly below the level modelled for FY23–25). On this basis, the implied valuation in sterling is £60.68, using an exchange rate of $1.24/£. This represents a premium of 39% to the current share price. Our last published valuation was at £68.20 in August, at the lower WACC.

The exhibit below shows the long-term revenue performance and the achieved EBITDA margin. The impact of COVID-19 is clear across FY20 and FY21, as is the resumption of growth. As discussed above, the business model is relatively straightforward, with sales responding to the marketing effort, with revenue per marketing dollar a (genuine) KPI (see Exhibit 6, above).

Marketing expenditure is the largest line item in the operating expenses, at 10.6% of revenue in FY22 (FY21: 15.3%), with staff costs the next largest at 7.6% (FY21: 8.5%). The step up in marketing efficiency following the changes to spending mix to include brand awareness shows clearly also in the EBITDA margin. We believe that this new level of return should be sustainable.

The recent trading update described order intake for the year to end-October 13% ahead of the prior year, a slowing from the 18% growth reported at the interims, as the group reaches more demanding comparatives. With a 1% uplift in order values, this is a substantial outperformance of the market, where industry-body ASI estimates Q323 sales revenues up by 2.4%, giving year-to-date growth of around 3.7%. At the time of the interim figures, management was guiding to FY23 revenues slightly over $1.3bn and pre-tax profits of €125m. With the Q323 trading update, this guidance was revised. The revenue figure was left unchanged, with the pre-tax figure lifted to ‘not less than $130m’ and this is reflected in our updated modelling. For FY24, we have very slightly moderated our revenue estimate from $1.45bn to $1.43bn but upped our PBT figure by $1m to $142m.

We have introduced estimates for FY25, which are predicated on top-line growth of 4.9% and a stable EBITDA margin of 10.3%. This rate of growth is below the 10-year FY13–22 CAGR of 14.7%, to reflect the degree of uncertainty on the geopolitical and macroeconomic outlook in North America.

Rather than simply examine the latest period of cash generation, we feel it is more useful to look at the long-term pattern of generation and use of cash, shown in the exhibit below for the 10 years from FY13 to FY22 (starting there simply because that was when our detailed modelling started).

This exhibit clearly illustrates how inherently cash generative the group is, as well as how modest the requirements for capital expenditure are to support the scaling up of the business. The two main uses of cash have been for dividends and to fund the legacy pension scheme. The issues regarding the latter have been addressed over a number of years, culminating in the buy-in of liabilities described below.

There has been capital expenditure, and this has been directed in the main to increasing capacity at the distribution facility in Oshkosh, adding capabilities in embroidery and screen-printing as well as increasing the footprint. The most recent spend has been on adding a 2,660-panel solar array, at a cost of $1.82m, which became fully operational in December 2022. This should be sufficient to provide up to 40% of the current distribution centre requirements.

A new project is currently in progress to extend the Oshkosh distribution centre further, adding 160k ft², with the bulk of the $20m budgeted cost to fall in the FY24 accounting period (as we model). The previous extension (in FY19) was intended to cater for the group’s expansion plans over a five-year period. This project now represents the subsequent phase, with a similar utilisation horizon.

There was also a small acquisition in FY22 of a local screen-printing company, Fox Graphics, for $1.7m, which has enabled the group to bring this activity in-house. Generally, though, M&A is not a feature of the business development, as market share can be grown more effectively and efficiently organically.

For the dividends (declared in US dollars and paid in sterling), cover has historically been around the 1.7–1.8x level. However, payments were suspended over the pandemic-affected period of FY19–20, when management’s priority was to preserve the financial health of the business and ensure that it would be in a position to take advantage when demand re-emerged.

In FY22, the accumulation of cash on the balance sheet reached levels where it was becoming a distraction for some investors and a special dividend of $2.00 was declared in addition to the ordinary dividend of $1.60.

The legacy defined benefit pension position has been carefully managed over the last few years to reduce the potential risk and with an eye to getting the funding to a position where a buy-in could be carried out. The ambition was to achieve this mid-2024, but it was in fact achieved in July 2023, via a bulk annuity policy with fair value matching the insured liabilities. This eliminates risks from inflation, interest rates and longevity and removes volatility from 4imprint’s balance sheet. Management is accelerating most of the previously agreed schedule of recovery contributions through to September 2024 with a cash top-up of around $4m, which was paid in July 2023 and is now reflected in our modelling.

The long-held strategy of maintaining a strong, cash-positive balance sheet really proved its worth over the pandemic-affected years, enabling management to take a longer-term view and carry the additional costs, which gave 4imprint a clear advantage when demand picked up again. There is no debt on the balance sheet bar the lease liabilities, which amounted to $13.0m at the half year. The group does have an undrawn, committed $20m line of credit available, should it be needed.

We model a year-end cash balance of $84m, which may prove overly conservative, given that the net cash balance as at the end of October was $95m, after the payment of the interim dividend at a cost of $17.7m.