Small-cap investors, it’s often said, are a glutton for punishment. Academic literature has proven the returns to those who fish for market minnows are, over long periods of time, better off than their whale-hunting counterparts. But that’s assuming, of course, one has the fortitude for an activity in which 20 per cent drawdowns are a regular occurrence.
The FTSE 250 this year is a case-in-point. Despite a 36 per cent bounce off the depths of the Covid-induced March lows, the mid-cap index is still down 19 per cent year for the year. The pain is only heightened when comparing its returns to the US’s small and mid-cap index, the Russell 2000, which is down just 7 per cent.
For those with the constitution, however, the sell-off is still providing pockets of opportunity, particularly for UK-listed businesses which might as well be American.
Enter 4imprint, a £560m seller of customised promotional products whose offices are not in the UK, but in the often-frozen plains of Oshkosh, Wisconsin. A town made famous of late for being the setting for Netflix’s Making a Murderer.
4imprint, however, isn’t quite as juicy a proposition because whether it’s in the wearing or purchasing, the $26bn branded swag market doesn’t quite hold the attention a potential miscarriage of justice does. But don’t let that fool you. Over the past decade, the company’s returned 2,263 per cent, including dividends, to shareholders and that’s including the 41 per cent drop so far this year:
Formed from the remains of British printing firm Bemrose Corporation, 4imprint’s transformation began in earnest when now chief executive Kevin Lyons Tarr took hold of the US business back in 2004. Under the auspices of turn-around specialist Hanover Investors, 4imprint’s sharpened its marketing efforts, divested its lagging UK business and shrank its pension deficit. By the time Tarr took charge, the US business had become almost all of its revenues and its stock a rare small-cap success story.
Part of the beauty of the model is that, like US aero-parts specialist TransDigm, 4imprint’s reliability, service and speed made it a go-to when a corporate marketing department needs to purchase its swag. To boot, the low dollar amounts spent per transaction means customers rarely balk at small price rises, or need to get their expenditures signed off by the controlling financial officer, giving the company both pricing power and the privilege of quick cash collection.
These factors translated into an unerring consistency in the businesses performance. Whether it be its cash to profit conversion, its 80 per cent plus return on equity, its mid-teen revenue growth or its high customer retention rates, 4imprint performed year after year after year. Boring, as it turns out, isn’t such a bad thing.
The pandemic, however, changed that. A retrenchment in marketing spending by 4imprint’s corporate customers meant revenues fell 34 per cent to $265m in the first half of 2020. Profits, unsurprisingly, vanished. None of this would have been a surprise to investors given how tied the business is to the health of America’s mom-and-pop businesses. After all when budgets tighten, marketing is one of the easiest expenses to turn off to preserve cash.
Cratering numbers would be a problem for 4imprint if it didn’t run a tight ship, but the company’s balance sheet is debt free with a net cash position of just under $40m. In a testament to its cost control, in the first half of the year 4imprint still managed to make a lump contribution of $9m to its legacy defined contribution plan which was agreed before the pandemic hit. Although it did have to sacrifice a $16m dividend payment for those pensioners, a trade-off that might strike some more aggressive shareholders as unnecessary.
Such a clean bill of corporate health should be beneficial to the business when the US economy begins to heal, however. The promotional products market is extremely fragmented: broker WHIreland estimates that there are 40,000 companies in the US alone competing over the $26bn pie, with just 0.001 per cent of them posting revenues over $40m. As the largest distributor, 4imprint should be able to add to its estimated 3 per cent market share if even just a handful of its tiny competitors shut up shop.
The problem is more not when that economic recovery comes, but in what form. 4imprint has re-orientated its business of late to focus on branded apparel but with online shopping eating the world, there may be less need for logo-totting retail assistants on shop floors or gas station forecourts. It also goes without saying that a lot of corporate tat is handed out at trade shows which, along with other mass-gathering businesses such as live music, will likely be one of the last industries to fully recover. If they recover at all.
Another long-term concern has been that Amazon might come along and eat 4imprint’s lunch. Yet, as the promotional products industry is low margin and the entire market is only 8 per cent of the Seattle’s company’s trailing 12 months revenues, Bezos probably has bigger fish to fry.
Worries, however, are feeding through to analyst estimates, with the number crunchers expecting 4imprint to only fully recover by 2022. Yet, with it’s current enterprise value at just under 14 times last year’s operating profits, it still seems pretty cheap, particularly when you consider the heady multiples attached to other growth-at-a-reasonable-price businesses stateside.
One way to close the transatlantic valuation gap might be to re-list in the US. The explosive success of online gambling company GAN’s recent migration to the Nasdaq from AIM demonstrates that a fresh set of investor eyes can make a material difference to a company’s valuation.
The politics would be tricky, however. Such a move would likely disappoint 4imprint’s loyal UK-based shareholders, some of whom would have to sell their stakes to avoid a conflict with their investing mandate. Given the company’s stakeholder driven approach, this seems unlikely.
Absent a trip across the pond, 4imprint’s depressed valuation, polished balance sheet and history of consistent cash generation may also prove tempting to a private equity buyer. Of which, as you may know, there’s no shortage of.
Quality, mundane businesses like 4imprint don’t grab the headlines but they often make for excellent investments — just ask WD-40’s shareholders. Rarely, however, do they go on sale. Investors should consider whether 4imprint’s valuation represents one of these opportunities, or a new normal for the branded tat trade. On balance, we’d plump for the former.