Gralynchett (at least that's what I think it is),Thanks for the...

Gralynchett (at least that's what I think it is),

Thanks for the compliment; I don’t think I’m anything special as an investor...all I am is driven by a loathing for making an investment in which the value of my capital is ultimately permanently reduced. Temporary impairment of my investment value I can live with, but not permanent loss of value. That I hate.

You were asking how I value DLX.

Specifically: “Do you still see this as good value from a current valuation perspective or are you buying/holding based on the quality of the business and the likelihood that it will be able to grow the value of the business in the future?”

The answer lies definitely in the second half of your question, i.e., I continue to own the business because I believe it will continue to increase in intrinsic value.

However, I must stress that I don’t do this in a simple blind faith fashion.

Without fail, I always start off researching an investment opportunity with an evaluation of the potential risks.

In dimensioning the investment risks – or at least in attempting to do so in a qualitative sense - I spend significant amount of time and effort in considering a number of factors under the following broad categories:

1. The financial pedigree of the business, and all the things that this encompasses, such as:

a. Brand recognition/Differentiated service offering
b. Commercial/economic “moat”
c. Operating margins
d. Capital intensity
e. Financial track record
f. Stability of earnings
g. Surplus capital generating ability
h. Balance sheet robustness
i. Underlying organic growth rates
j. Investment in R&D/Brand

2. The structure of the industry in which it operates:
a. Market position/Brand resonance
b. Competitive landscape
c. Supplier dominance or dependency
d. Scope of technological obsolescence
e. Difficulty or ease to replicate the business
f. Regulatory risks

3. The competence and trustworthiness of its management

a. Board composition and skillset
b. Track record of shareholder value creation
c. Remuneration structures and alignment of senior management with shareholders

4. Quality of Financial Statements

a. Conservativeness with which accounts are presented
b. Appropriate revenue recognition
c. Extent of capitalisation of operating expenses and/or interest
d. Conservative depreciation policies
e. Reconciliation of Cash Flow Statement with Income Statement
f. Nature of Non-Recurring Items
g. Profits/losses recorded on asset sales
h. Debtor provisions and arrangements
i. Quality of inventory
j. Adequate and appropriate levels of provisioning
k. Related party arrangements and transactions
l. Contingent liabilities
m. History of asset writedowns


Now I readily concede that this sort of exercise is not an exact science. It is certainly not something that can be dimensioned in a quantitative measure that can be meaningful, for example: DLX has a Risk Coefficient of 4.9, whereas BHP’s is 6.4 and TLS’s is 3.7, or something along those lines.

So, while it is possible to quantify some of the items listed above to facilitate direct comparisons, the OVERALL “risk view” that emerges is, by its very nature, a qualitative one.


For example for DLX, marked on the I consider the risks to be quite low (the Alesco acquisition changed that view a bit, because I am still rankled by it to a degree, but that’s a separate subject). If you held a gun to my head and said I had to pick a number from 1 to 10 (1 being lowest risk, 10 being highest), then I’d say DLX is a 3 or a 4.

And the next step is for me to decide what rate of return I would be happy to accept for that level of risk.

In DLX’s case, something like a 15% pa Total Shareholder Return (defined as Capital Growth plus Dividend Yield) “feels” about right to me.


Getting to that stage is what takes all the hard work.

From here determining whether the stock is under- or over-valued it is quite mechanistic. It simply involves a very simple Excel spreadsheet that has a very basic Income Statement and Cash Flow Statement modelled out a few years, with resulting valuation multiples (P/E, EV, FCF Yield and DY) hanging off the bottom.

What I then do is I assume an appropriate exit set of valuation multiples (admittedly this is a pretty critical input and requires a degree of analytical judgment and experience as to what how market will be prepared to capitalise Earnings, Free Cash Flow and Dividends at some point in the future.

With this constraint place on the model, and with my Required Rate of Rate of Return (RRoR) also superimposed, I then solve for the implied rate of growth in Revenue, Profits, Free Cash Flow and Dividends over my investment time horizon (usually three to five years).


It is difficult to describe this interplay accurately and succinctly in words, and it would probably best observed if you had the spreadsheet directly in front of you, but to finally answer your question as to how I see DLX’s valuation stacking up, this reverse engineered approach currently suggests the following:

Assuming the stock holds its current valuation multiples of around 19.5x P/E, 11.5x EV/EBITDA, 5% FCF Yield, DLX would need to grow Revenue by 8% pa, EBIT by 12%pa and NPAT by 15%pa over the next few years, and that would deliver me my RRoR of 15% pa.

In that case, because that rate of growth is, in my view, readily achievable, I consider the stock to be still undervalued.


Of course, you might argue that current valuation multiples are unduly generous, and that “appropriate” multiples are more likely to be closer to P/E = 16x, EV/EBITDA = 10.0, and FCF Yield = 6%.

At the same growth metrics used before (Revenue = 8%pa, EBIT = 12% pa, and NPAT = 15% pa), that yields an 11% Rate of Return (8% pa Capital Appreciation and 3% DY).

Which I still think is acceptable, albeit not sensational.


Finally, the logical question to ask is, what sort of future growth is the current share price implying, assuming multiples of P/E = 16x, EV/EBITDA = 10.0, and FCF Yield = 6%?

The model – and again, it’s not overly sophisticated, but it would be better explained if you had it in front of you – solves for 4% pa Revenue growth, 7% EBIT growth and 9% NPAT growth.

Given the track record of the business, this outcome I would consider to be unduly conservative and unlikely to eventuate.


So, to conclude: very long answer to a very simple question: No, I do not consider DLX to be overvalued. The Return-to-Risk equation for the stock is no longer mouth-wateringly attractive, but it is still favourable, I estimate.


Clunky explanation I know, but I hope this helps.

Happy painting.


Cam