Verifone (PAY) a Cyclical Stock Capable of Generating Super GDP Growth

Verifone (PAY) is an equity that gave results recently and the stock market  was very impressed. Verifone is an exciting growth stock and is good to research because it offers a cyclical growth story that should deliver earnings and revenue growth in excess of GDP growth. This article is intended to provide some brief equity research. Any comments, positive or not, are welcome. I believe Verifone to be a stock that is worth if consideration to an equity investors portfolio.

Verifone is the global leader in secure electronic payment solutions. The idea behind this play is that there is an inexorable shift towards using electronic payments instead of cash and cheques to pay for Point of Sale (PoS) purchases. Verifone make the Electronic Point of Sales (PoS) terminals that you might be asked to pay with in the retail environment.

As such, their fortunes are tied to the cyclicality of the economy, but they should be able to achieve super GDP growth as these terminals are expanding market share. Similarly, as more of them are used (due to increasing growth in the economy) they are subject to wear and tear and, the upgrade cycle should be reduced. Finally, International expansion (particularly in emerging markets) offers strong growth prospects. Many countries in the world are significantly behind US adoption of electronic PoS and furthermore, many are not even used to using electronic payments. Therefore, long term growth prospects are good.

Verifone has recently announced the acquisition of Hypercom (number three in market) which should complete in H2 of 2011. This would make Verifone the market leader, ahead of Ingenico of France. Indeed, the sector is undergoing consolidation and I would expect the market leaders to be able to increase margins according. In this analysis, I will focus on Verifone and then make concluding remarks about the intended Hypercom acquisition. The Hypercom deal makes execution sense-it will consolidate the industry-but also strategic, as Hypercom are well placed in emerging markets.

A quick look at the Geographic breakdown of revenues reveals where the growth is coming from

		Three Months Ended October 31,									Twelve Months Ended October 31,
		2010			2009			Change			2010			2009			Change
United States and Canada		$	122,109		$	86,998		40	%		$	440,873		$	343,042		29	%
Europe			70,166			68,485		2	%			268,197			265,548		1	%
Latin America			53,887			35,563		52	%			197,804			150,071		32	%
Asia			29,809			26,783		11	%			94,663			86,053		10	%
		$	275,971		$	217,829		27	%		$	1,001,537		$	844,714		19	%

source: Verifone

These earnings are  complemented by Ingenico's recent numbers, who have been reporting weak North American performance but strong Asian Growth. Ingenico are currently better placed in Europe and in particular in Spain and Portugal. I suspect these markets will face difficulties over the next few years as EPoS is very well established in Spain. According to Verifone's presentation, Spain is only bettered by the US in terms of PoS devices per population. I favour Verifone.

Looking at the trading history...

	To October
	2007	2008	2009	2010
Revenue	902,890	921,930	844,714	1,001,537
Gross Profit	299,232	293,031	282,129	370,312
Margin	33.14%	31.78%	33.40%	36.97%
Operating Profit	28,480	-315,823	-128,966	102,424
Margin	3.15%	-34.26%	-15.27%	10.23%
Pre-Tax	-9,298	-351,438	-148,209	78,245
Margin	-1.03%	-38.12%	-17.55%	7.81%
Current Assets	603,582	562,850	622,193	761,091
Current Liabilities	306,767	266,534	245,653	259,806
Assets/Liabilities	1.97	2.11	2.53	2.93

source: Verifone, Earnings View

...we see that they suffered with the cyclical slowdown in 2008-2009. However, gross margins are improving and -as the last section indicates- the business is generating cash flows. Verifone has always generated good cash flows. I've attached some previous cash flow data with my estimates as to what they could do in the next few years...

2007 2008 2009 2010 2011Est 2012Est Revenue 902,890 921,930 844,714 1,001,537 1,140,000 1,254,000 Net Profit -34,016 -425,322 -157,455 98,827 144,845 175,570 Margin -3.77% -46.13% -18.64% 9.87% 12.71% 14.00% Op CF 76,738 21,683 100,987 158,868 199,845 230,570 Working Capital 12,532 -30,311 101,622 -2,842 -11,400 -12,540 WC % Turnover 1.39% -3.29% 12.03% -0.28% -1.00% -1.00% Net Op CF 89,270 -8,628 202,609 156,026 188,445 218,030 Margin 9.89% -0.94% 23.99% 15.58% 16.53% 17.39% Capex -37,965 -22,051 -12,054 -11,578 -17,100 -18,810 Capex % Rev -4.20% -2.39% -1.43% -1.16% -1.50% -1.50% FCF 51,305 -30,679 190,555 144,448 171,345 199,220 FCF% Rev 5.68% -3.33% 22.56% 14.42% 15.03% 15.89% FCFYield 1.47% -0.88% 5.44% 4.13% 4.90% 5.69%
source: Verifone, Thomson/First Call,Earnings View These numbers are based on a share price of $39.87 and a market cap of $3.5bn. They assume EPS of $1.65 (midpoint of their recent guidance) for 2011 and $2 for 2012. I've assumed 10% revenue growth for 2012. I haven't included Hypercom in these numbers. Frankly, a 5% forward free cash flow yield is close to what I would pay for this type of business, particularly as they have the added risk of the Hypercom integration. However, this risk needs to be balanced by the growth prospects and synergies to be achieved. Furthermore, Verifone will see upside, given an improvement in the global economy. It is the uncertainty over the knock on effect of European growth prospects that causes concern here. If they prove to be dissipated then current trends for the US and Emerging Markets look to be very strong and Verifone's prospects look very bright. If European bond yields remain high than the effect on retail could be significant. Whereas I think around $40 provides a fair approximation of the risk/reward calculation, this target should be raised to, say, $45 given a stabilisation in Europe and/or continuation if US growth prospects. Otherwise, I will monitor Verifone with a view to picking some up on weakness. This is a very attractive industry and, if you are looking for some cyclical exposure than I think Verifone is a good stock to look at. Source: Verifone Presentation              Verifone Results

							.

Galapagos NV. An Exciting and Well Balanced Biotech Stock Gives Pipeline Update

Galapagos NV is a Belgium based biotech stock. It is profitable and cash flow positive. Galapagos business model is a combination of selling their drug discovery services (Biofocus and Argenta) to big pharma co's (ex Glaxo SmithKline, Johnson & Johnson, Lilly, Merck and Roche) whilst having a proprietary and partnered development program. As such, they are self funded and sustainable. Thet also have a large-but very early stage-pipeline.

Today they announced that one of the five of their own programmes had successfully completed it's first in human trial. GLPG0429 is a drug in trials for cachexia (weight and muscle mass loss)  but they also believe it could be indicated for Duchenne muscular dystrophy.

This was a Phase I trial intended to demonstrate safety, tolerability and pharmokinetic profiling. No adverse effects were reported. They expect to conduct another Phase I to assess safety and tolerability in 2011, with a proof of concept trial pencilled in for late 2011.

As outlined above, Galapagos has a very early stage pipeline, but this flow of news is positive. Galapagos is a longer term speculative play, whose downisde is limited by their drug discovery services, yet provides good upside potential.

source: http://www.glpg.com/press/2010/43.htm

RPC plc. A Plastics Packaging Company and Restructuring Story.

RPC is a supplier of rigid plastic packaging.  It is an interesting stock because it gives you the chance to play lower oil prices (margins should improve) not only via lower polymer prices but also via lower energy prices. Conversely, margins would fall should they oil prices go up.

RPC’s end markets tend to be loaded towards the food sector and also towards household consumer products like lipstick cases and coffee capsules etc. As such, they can be seen as a defensive play. They sell primarily into Europe, having expanded into Continental Europe over the years. The three divisions of thermoforming, injection moulding and blowforming are all single digit margin businesses.

Even though they are defensive in their end markets, they are still cyclically exposed because when economies slowdown in industries like plastics manufacturing-capital intensive, operators need to keep capacity utilisation high-they usually get price competitive and try to grab market share.

Before showcasing the numbers, I should point out that these numbers are adjusted to exclude restructuring costs. And there has been a lot of restructuring over the years! In a sense, the story of RPC is a company struggling against rising commodity costs whilst refocusing their activities and making cost efficiency savings.

RPC					Year to March
			2006	2007	2008	2009	2010
Turnover			611.5	645.7	695.2	769.1	719.9
Adjusted Operating Profit			36.8	38.1	40.6	35.5	40.9
Margin			6.02%	5.90%	5.84%	4.62%	5.68%
Inventory			86.37	94.20	110.30	87.90	96.40
Inventory Days			54.85	56.59	61.50	43.73	51.82
Debtors			117.29	128.20	139.90	120.70	125.80
Debtor Days			70.01	72.47	73.45	57.28	63.78
Creditors			135.87	130.80	157.70	164.60	185.60
Creditor Days			86.29	78.57	87.93	81.90	99.77
Op Cash Flow			66.60	65.10	56.20	49.60	55.90
Working Capital			-2.09	-24.20	7.30	65.60	15.50
Tax			-9.67	-7.50	-10.90	-5.10	-2.20
Interest			-7.92	-8.40	-10.60	-10.60	-4.50
Net Op Cash Flow			46.93	25.00	42.00	99.50	64.70
Capex			-50.31	-35.50	-33.40	-33.40	-28.00
FCF			-3.39	-10.50	8.60	66.10	36.70
FCF*			-1.30	13.70	1.30	0.50	21.20
FCFYield			-1.17%	-3.64%	2.98%	22.91%	12.72%
FCF*Yield			-0.45%	4.75%	0.45%	0.17%	7.35%
FCF*Normal			5.44%	5.27%	1.39%	-0.24%	5.13%
Depreciation			-33.31	-34.00	-30.70	-34.60	-34.40
Capex/Dep			1.51	1.04	1.09	0.97	0.81

I should explain that FCF* is simply free cash flow but with working capital neutralised. Similarly, FCFNormal is the free cash flow whereby I have equalised capex with depreciation. It helps to get a clear picture of what is going on.

Again, I should point out that almost every year there have been substantive restructuring. However, RPC know feel that they are beyond the restructuring phase and can now pursue growth. Indeed, free cash flow generation has been very strong recently but I suspect there will be some 'payback' as inventory levels may need to rise. Similarly, I'm not sure if the change in working capital (from a negative to a positive) is sustainable going forward. Their working capital requirements are somewhat dependent on where commodity prices go.

Longer term growth rates look to be around 4% but there is a cyclical element which will be tied to European growth rates. They do try and pass on oil price rises but are susceptible to sharp and volatile upwards movements.

In general, I like the restructuring here and think the current share price gives good value. However, I did not take a position as -short term- there are significant questions over the ability of European consumers to borrow as a result of the Sovereign Debt Crisis. The nightmare scenario for RPC would be surging Oil prices driven by emerging markets and speculation, coupled with European consumer entrenchment over austerity measures.

However, this is definitely one to monitor.