RR Donnelley & Sons Co (RRD): 6.0% Yield & Value Creating Spin-Offs by Ben Reynolds, Sure Dividend
The first thing that jumps out about RR Donnelley (RRD) stock is its massive 6.0% dividend yield. RR Donnelley has paid steady or increasing dividends every year since 1985. Click here to see 12 other high dividend stocks.
Steady or increasing dividends since 1985 is impressive. What’s less impressive is that RR Donnelley has not increased its dividend payments since 2003. The company has paid $1.04 a share per year since 2003. Steady dividends aren’t bad, but they don’t give investors rising income.
RR Donnelley has not paid increasing dividends since 2003 for good reason. Earnings-per-share were $1.65 in 2004. In fiscal 2014, earnings-per-share were $1.64. The company has not been able to grow earnings-per-share in over a decade. This is not a good sign for investors. The company’s operations are analyzed below to see why growth has stalled – and if the company will return to growth in the near future.
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RR Donnelley Business Overview
RR Donnelley is the world’s largest commercial printer. The printing industry is in slow decline as electronic communication supplants printed channels. With that said, the printing industry is far from dead. Case-in-point; RR Donnelley made $328 million on revenues of $11.6 billion in 2014.
What is troublesome about RR Donnelley is its large debt load. The company currently has around $3.7 billion in debt. The company’s fiscal 2015 guidance calls for the following:
- Interest expense of around $272 million
- Adjusted EBIT of around $971 million
The company has an interest coverage ratio of about 3.7x. What is troublesome about RR Donnelley’s high debt load and fairly tight interest coverage ratio is its lack of growth, declining margins, and cash flow declines during recessions.
In 2005, RR Donnelley had an operating margin of 15.5%. By fiscal 2014, the company’s operating margin had fallen to 9.7%.
RR Donnelley’s earnings-per-share reached record highs in 2007 of $2.94. In 2009, earnings-per-share declined 65% to $1.03.
If margins continue their downward trend, or if another severe recession occurs RR Donnelley could have difficulty financing its debt obligations and potentially face bankruptcy.
RR Donnelley currently operates in 4 segments:
- Variable Print
- Publishing & Retail Services
- Strategic Services
The image below shows the percentage of revenue from each of the company’s segments (and sub-segments).
Source: RR Donnelley Best Ideas Conference Presentation, slide 5
RR Donnelley is well diversified across its segments. All of the company’s various business units have low capital intensity; they require little invested capital to produce cash flows. Low capital intensity businesses typically generate strong free cash flows as less money is needed for capital improvements.
The image below highlights the company’s low capital intensity across segments, as well as the growth expectations for the company’s different segments.
Source: RR Donnelley Best Ideas Conference Presentation, slide 6
As you can see, both the publishing & retail and variable print segments have negative expected growth. The International segment is really a mix of the company’s 3 core business segments that are operating outside of the United States. Only the strategic services segment is expected to provide positive revenue growth going forward.
RR Donnelley’s Bold Growth Plan
RR Donnelley’s management has decided to split the company into 3 smaller businesses by the end of 2016 (pending regulatory approval which should not impede progress) via a tax free spin-off. The company will pay its current dividend until the spin-off is complete. Capital allocation (in particular, dividends) policy will be updated in each of the 3 businesses after the spin-off is complete. The 3 businesses post-spin off will be:
- Customized Multi-Channel Communications Management (abbreviated as CMCo)
- Publishing & Retail-Centric Print Services (abbreviated as PRSCo)
- Financial Communications Services (abbreviated as FinancialCo)
The image below shows the expected revenue growth rate and total expected revenues of each of the 3 companies:
Source: RR Donnelley Best Ideas Conference Presentation, slide 14
The spin-offs will create 2 businesses with relatively slow revenue growth, and one business (PRSCo) with negative revenue growth. This will give current investors in RR Donnelley the chance to benefit from the company’s positive growth operations without investing in the declining publishing and retail print business.
This solves the ‘negative growth problem’ that is holding down RR Donnelley’s share price. While vague, it appears that the slowly declining print business will be saddled with much of the company’s debt based on the quote below from the ‘Best Ideas Conference Presentation’:
“It is expected that the currently outstanding RRD notes will remain at CMCo and that CMCo will receive certain cash proceeds in connection with the capitalization of each of PRSCo and FinancialCo”
Overview of RR Donnelley Post Spin-Off
A brief description of each of the ‘new’ post spin-off companies is below.
CMCo will provide retail/brand execution of labels, point-of-purchase displays, packaging, print, and digital marketing. In addition, CMCo will offer its customers logistics services and value-added services including project marketing, project management, and communication.
FinancialCo will provide financial management services to businesses. Services offered include IPO documents, proxies, shareholder report solutions, delivery of investor communications, regulatory filings, report management solutions, and data analytics.
PRSCo will provide traditional publishing and retail print services. Key print products are: books, magazines, directories, retail inserts, catalogs, and office products.
Spin-Offs Unlock Value
The break-up of RR Donnelley will unlock value for shareholders. The company has traded for a price-to-earnings ratio under 11 for much of the last 5 years. RR Donnelley’s forward price-to-earnings ratio is currently just 10.3.
With two of the 3 spin-off companies expecting positive revenue growth, the split-up value of RR Donnelley’s assets is greater than its current value.
I believe that both FinancialCo and CMCo will likely trade for price-to-earnings multiples of at least 15 if they maintain their revenue growth targets. Additional growth will come from a better focused management team.
PRSCo will likely maintain a low price-to-earnings ratio as its lack of growth and declining market does not bode well for shareholders. PRSCo’s management will hopefully manage the company as a cash-cow and return nearly all cash flows to shareholders in the form of dividends.
RR Donnelley’s break-up will very likely prove to be beneficial for shareholders. The company’s 6.0% current dividend yield is more-than-fair compensation while investors wait for the break-up to unlock value.
The company is not a traditional dividend growth stock. RR Donnelley’s poor growth over the last decade prevent it from ranking highly using The 8 Rules of Dividend Investing.
With that said, I believe RR Donnelley shareholders will see significant capital gains once the spin-offs complete near the end of 2016. Investors will also receive a 6% return from the company’s dividends while they wait. The lack of a consistent dividend policy (as of yet) post spin-off makes this stock a poor choice for strict dividend growth investors. RR Donnelley is a compelling purchase at current prices for value investors willing to hold through the spin-off.