Stockwatch: Will new strategy deliver a recovery?

by Edmond Jackson from interactive investor |

This US stock is facing short-term pain, but can its new strategy reward investors over the long-term?

Many US stocks in well-established businesses trade on high ratings versus cyclically-adjusted earnings - making their selection largely a game of guessing macro trends, such as shifts in US monetary policy or whether corporate profits have peaked after President Trump's tax cuts created a sugar rush.

So, it's interesting to a see a stock take a massive hit on surprise news that compromises earnings in the short to medium term but could work out as a smart strategic decision. The possibility is that sentiment has swung too negatively versus long-term fundamentals.

Thus internet-based postage group Stamps.com (NASDAQ:STMP) saw its Nasdaq-listed shares (STMP) plunge nearly 60% to $83.65 last Friday, despite declaring Q4 2018 net income up 6% to $42.7 million on revenue up 29% to $170.2 million, as management dropped historic reliance on the US Postal Service (USPS) "so we can fully embrace partnerships with other carriers who we think will be well-positioned to win in the shipping business in the next five years."
 
That makes sense given the way "shipping" (i.e. delivering items), is diversifying away from traditional service suppliers, who can often present better terms.

In the same way as the UK's Royal Mail (LSE:RMG) has been undermined by the likes of Amazon (NASDAQ:AMZN), Hermes (EURONEXT:RMS) and Yodel, Amazon under-cuts USPS charges by about one half while UPS (NYSE:UPS) and FedEx (NYSE:FDX) do so by one third.

2019 downgrades, potentially stronger long-term

Revenue guidance has been downgraded roughly 5% to $555 million (at the mid-point of estimates) compared with 16% growth previously; although adjusted earnings per share roughly halves to a $5.15 to $6.15 per share range, versus a $10.8 per share consensus previously, due to the imminent loss of high-margin commission within USPS revenues – as Stamps.com breaks with an exclusive arrangement.

On Monday its stock rebounded 18% to about $99, which implies a forward price/earnings multiple (P/E) in the high teens, some would say higher still if taking a stricter "GAAP" view (generally accepted accounting principles).

But if – and speculation is involved here – management has good grounds for its move by way of new partnerships to declare in due course, freed of its exclusive tie to USPS, then revenue sources will diversify and potentially increase.

Durable customer franchise has evolved since 1996

Stamps.com originated in 1996 as one of the first companies to get USPS approval for digital delivery - of special appeal to smaller businesses. Stamps and shipping labels are printed simply by way of an internet connection and PC/printer, also using a digital scale (subscribers are sent) to weigh envelopes and packages.

Mailings and packages can then be tracked too. The cost is $18 a month with postage additional, which attracts criticism in some online reviews when people forget to cancel the subscription if they’re not using it, saying it wasn’t made clear enough.

Others however praise the convenience and lower costs over times, and respecting this the customer franchise comes across well. Searching online I see that scores on the Better Business Bureau reviews of US firms, have improved from 1 star overall in 2015, to 4.5/5.0 based on an average of 335 customer reviews.

Obviously, the crux is how sometimes contrasting words translate into numbers, and paid customers were flat last year at 736,000; albeit consistent with a strategic focus on acquiring fewer customers with higher values, reflected in monthly revenue per customer up 29% to $74.93. The operating margin has slipped though, in a 3% range.

Stamps.com Inc.        
income statements $ million Three months ended December 31   Twelve months ended December 31  
         
  2018 2017 2018 2017
Revenue 170.2 132.5 586.9 468.7
Cost of revenue 38.8 20.9 126.9 79.2
Gross profit 131.4 111.6 460.0 389.5
Operating expenses 77.4 60.1 265.6 226.0
Operating profit 54.0 51.5 194.4 163.5
Operating margin % 3.2 3.9 3.3 3.5
Net interest expense 0.8 0.8 2.5 3.3
Pre-tax profit 54.2 50.7 190.9 160.3
Taxation 10.6 10.5 22.3 9.6
Net income 42.7 40.2 168.6 150.6
Net income per share (diluted) 2.3 2.2 9.0 8.2

Source: Company REFS    Past performance is not a guide to future performance

Consolidating smaller digital postage operations

Stamps.com has become a leading global e-commerce shipping software company with the help of acquisitions since 2013, including London-based MetaPack for £175 million last July – which helps out for example, Amazon Prime sellers in the UK.

The US industry is largely controlled by three big traditional carrier firms - UPS, FedEx and USPS - with e-commerce the fastest growing element at about 16% annually.

US industry package revenue is expected to grow by 40% from 2017 to 2022, and cross-border e-commerce by 28% over the next three years. In such a context it's logical for Stamps.com to offer its brand to other and emerging carriers, best-placed to capitalise on this trend.
 
As a result, management is seeking to expand the company's network of carriers, including Amazon, towards a spread of 40 in the US and 450 worldwide. In the latest results' earnings call the CEO was ambivalent when questioned exactly what is the current relation – or mainly potential? – with Amazon, talking in general terms how once deals are set up with other carriers then strength of the wider e-commerce sector will affirm revenue growth.

It's also hard to specify the context for benchmarking progress on carriers when, for example, MetaPack alone was described last July as having 450 carriers globally.

In the UK the board would be told to pay dividends

Stamps.com appears to assert itself as a capital growth stock: re-investing for development and keeping debts in check; but the concept got snared last Friday because a dividend yield may have helped put a floor to the stock instead of plunging nearly 60%.

Indeed, the end-2018 balance sheet shows plenty cash, if down from $153.9 million to $113.8 million in the context of debt down from $69 million to $60.6 million during the year.

Instead of pay-outs the board has carried out a $90 million share repurchase programme, chiefly in Q4 2018 for which the chart shows a range of $215 to $145. Unless the stock recovers to such levels, the buyback was arguably value-destructive.

Instead the company could have wiped out its debt and also paid a dollar per share by way of dividend. That's some opportunity cost!

Useful size, as a $1.8 billion company

If listed in the UK, Stamps.com would be a £1.4 billion mid 250 stock, effectively a small cap in US/global context despite an expanding global reach.

So, it is well-established while still a size where expansion can kick in usefully for profits. Digital delivery of postage should have a sound future for its convenience, linked to the expansion of online shopping/trading and home deliveries, able to amply substitute declines in letter volumes.
  
Recovery buyers of the stock are significantly trusting management knows what it’s doing by abandoning the exclusive arrangement with USPS, when as yet there is insufficient proof.

With that caveat however, Stamps.com will be interesting to follow and the uncertainty continues to offer buying opportunities as sentiment shifts. Assuming management declares new carrier partnerships then volatility should be mitigated. Long-term buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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