Frank Voisin writes about value investing topics at http://www.frankvoisin.com
Harte-Hanks, Inc. (NYSE: HHS) is a worldwide direct and targeted marketing company that provides multi-channel data-driven marketing solutions to companies operating in the retail, high-tech/telecom, financial services, and pharmaceutical/healthcare industries. The company focuses on data-driven marketing solutions which provide the clearest return to its customers. Additionally, the company is North America’s largest owner, operator and distributor of weekly advertising publications (known as “shoppers”) which are distributed freely to households by geographic area. The company’s shoppers reach 11.2 million households each week throughout California and Florida under the brands PennySaverUSA.com and TheFlyer.com.
The company has hit a rough patch through the recession, with reduced revenues translating to lowered profitability and free cash flow generation. Despite this, the company is still generating strong free cash flows, averaging $91 million over the last two years (down from its 10-year average of $108 million). Nevertheless, the company’s shares have declined (as of the time of writing) approximately 35% since the beginning of 2011, resulting in a market cap of approximately $530 million. This translates to a strong free cash flow yield of 17%.
Let’s take a look at the company’s historical performance.
Here we see the toll taken by the recession, with returns falling below long-term averages beginning around 2007 and continuing to the most recent year. Interestingly, CROIC has remained quite high throughout, suggesting the company has been more consistent in its ability to generate free cash flows.
This chart shows the split between the company’s Direct Marketing and Shoppers segments, as well as the dramatic decline in 2009 and 2010 (and continuing through 2011). Here’s what the company has to say about this decline:
Our businesses continued to face challenging economic environments in 2010, which negatively impacted our financial performance. Marketing budgets are often more discretionary in nature, and are easier to reduce in the short-term than other expenses in response to weak economic conditions. Difficult economic conditions and consolidation and bankruptcies of customers and prospective customers in the industry verticals that we serve have resulted in pricing pressures and in reduced demand for our products and services.
It is no surprise that the company is suffering reduced demand during a recession. Demand for its services scales back as business scale back on their advertising and marketing budgets. Unless you have a short-term investment horizon, it would be folly to focus on the last two years and assume this performance will continue into perpetuity. Rather, for those with a long enough investment horizon, there exists the luxury to consider normalized performance. In order to consider this, we have to determine first that the company will last through the ongoing economic turmoil. Let’s check the company’s capital structure.
Here we see that the company made the unfortunate decision to add debt to its balance sheet just prior to the recession. Luckily, the company has done a good job of reducing its debt, with a slight uptick in the recent quarter as it refinanced a portion of the debt. At the beginning of March, another term loan comes due and, according to the recent conference call [MP3], the company plans to repay it with cash rather than roll it over. The company added debt in 2005, 2006 and 2007, but what did it use that debt for? In large part, it repurchased shares much more aggressively than it had been previously.
As this chart shows, the company has done a good job in reducing its share count, which has declined approximately 32% since the 2001 peak. While the company stopped repurchasing in 2008, it recentlyannounced its plans to resume:
Harte-Hanks, Inc. today announced that it intends to purchase up to one million shares of its common stock during the remainder of 2011, resuming its existing stock repurchase program.
Since 2001, the company has spent net $820 million repurchasing shares. Beyond repurchases, the company also has a long history of paying dividends, dating back to early 1995.To date, the company has paid approximately $180 million in dividends and now trades at a strong 3.8% current yield.
Combined, the repurchases and dividends amount to approximately 90% of the free cash flow generated by the company, which I consider to be extremely shareholder friendly. It is perhaps not surprising that the company treats its shareholders so well – insiders own 31.6% of its shares!
Let’s go back to the beginning and look at the free cash flows I noted in the introduction.
Here we note the most remarkable aspect of HHS: its free cash flows. The company has generated remarkably consistent and strong FCFs with relatively low capital demands. Even with the decline during the recession (approx 20% using the last three year average versus the prior three year average), the company’s market cap has declined far more significantly (70% since prior to the recession!), such that the yield is quite strong even if levels remain depressed.
The company has not taken the recession lying down. Faced with declining revenues, management has expanded into different services (most notably its powersites operations which allow small businesses to set up their own template-driven domain, receive a unique phone number and domain based email account (for HHS’ analytics) and invested in automation and other technologies which reduce its costs.Additionally, the company is able to scale back on its Shoppers distribution as demand declines:
As a result of the difficult economic environments in California and Florida, we curtailed more than 1.4 million of circulation from July 2008 to February 2009. This consisted of approximately 850,000 of circulation in California and approximately 550,000 of circulation in Florida. We continue to evaluate our circulation performance and may make further circulation reductions in the future as part of our efforts to address local economic conditions in the California and Florida markets we serve.
Nevertheless, as the margins show in the second graph from the top, the company has been unable to reduce expenses in line with the declines in revenue. Part of this is due to the fact that the company’s Shoppers business is largely reliant on costs that are outside its control: the price of paper and the cost of shipping. Here’s what the company said about these expenses (emphasis added):
We are vulnerable to increases in paper prices
Newsprint prices have fluctuated in recent years. We maintain, on average, less than 45 days of paper inventory and do not purchase our paper pursuant to long-term paper contracts. Because we have a limited ability to protect ourselves from fluctuations in the price of paper or to pass increased costs along to our clients, these fluctuations could materially affect the results of our operations.
We are vulnerable to increases in postal rates and disruptions in postal services
Our Shoppers and Direct Marketing services depend on the USPS to deliver products. Our shoppers are delivered by Standard Mail, and postage is the second largest expense, behind labor, in our Shoppers business. Standard postage rates have increased in recent years, most recently in May 2009, and rates remain subject to further increases.
In valuing the company, I took into account an expectation that these costs will rise to become a greater proportion of revenues than they were historically. For all other operating expenses, I used long-term normalized rates a proportion of revenue. Additionally, I expected revenues to remain depressed for an additional two years (contracting each year) before a rebound beginning in 2014. I worked through to arrive at free cash flows, which I have projected to be below the company’s historical free cash flows. My conclusion is that HHS is significantly undervalued. In waiting for the market to react, an investor will also benefit from a good dividend yield.
What do you think of HHS?
Author Disclosure: No position, but may initiate within 72 hours
Frank Voisin writes about value investing topics at http://www.frankvoisin.com