The market’s uncertainty over the last couple of weeks appears to have raised the spectre of increasing downside risk, even as the market this week has managed to reclaim a portion of the drop to correction territory that started earlier this month. It is clear that while the stock market pushed past its pre-pandemic highs this summer, economic risks continue to exist that do not line up with the “V-shaped recovery” you can plot in the stock market.
It is interesting to observe the disconnect between broad stock market expectations versus the economic data that points to a much more gradual pace of economic growth. One of the places where I think that can be seen more easily is in evaluating large-cap versus small-cap stocks. Many of the biggest and most recognizable names in the market have followed the broad indices higher, and if you look at the fundamentals of many of those companies, there are clear indications that they have been able to navigate the uncertainty of 2020 better than their smaller brethren. That isn’t surprising, and it is a natural reason any smart investor, myself included, focuses on many of these companies first under these kinds of market conditions.
Small-cap stocks can be harder to evaluate – not because their management teams are less capable, or exercise less financial discipline, but simply because the size, scale and breadth of their respective businesses are usually more narrowly focused. That can put those companies at greater risk to forces – such as coronavirus – that may be entirely out of their control. The divide can become even wider if the sector or industry the company operates in also happens to lie on the wrong side of shifting economic winds.
The market has proven that since March, all sectors are not created equal. There are sectors that have held up extremely well even as global economic shutdowns sent workers home and closed just about every kind of traditional business activity. Those include companies that offer services and solutions that facilitate remote organizational connectivity and collaboration, which have helped a large portion of corporate America continue to function even while normal, in-office operations haven’t been possible. That shift has helped shield many of those companies from the worst economic impacts of the pandemic, but also looks like it could translate to a long-term shift away from traditional business operations, creating a ripple effect that could impact other businesses in a negative way.
One of the business segments that has already seen a negative impact, and that could continue to be effected for an extended period of time is the Commercial Services and Supplies industry. These are businesses that provide products and services to organizations – such as businesses, schools, and governments – in traditional office settings, which means that the longer it takes America to get back to the office, the longer it will take these companies to recover. That could mean that companies like ACCO Brands Corp (ACCO) may continue to struggle the longer a complete economic recovery takes. Along with the shift to remote work is the complexity most states have seen in reopening schools; across the United States, back to school has also corresponded with significant increases in infections among high school and college-age groups. ACCO’s management highlighted school reopenings as an ongoing, likely headwind in its latest earnings report – even more than remote work.
ACCO’s stock mirrored the broad market’s dip to bear market lows in March, with a sizable bounce from that point to create an interesting short-term upward trend into June that then flattened into a narrow trading range until the beginning of September. Since then, the stock has fallen back a bit below that consolidation range and looks like it could be establishing a new, lower consolidation base. The question for a value-focused investor is whether their fundamental strengths add up to the resources the company will need to weather a long-term decline in demand and make the shifts it will require? The answer to that question could define the difference between a great value opportunity and just a cheap stock.
Fundamental and Value Profile
ACCO Brands Corporation is engaged in designing, marketing and manufacturing of branded business, academic and selected consumer products. The Company operates through three segments: ACCO Brands North America, ACCO Brands International and Computer Products Group. The Company’s brands include Artline, AT-A-GLANCE, Derwent, Esselte, Five Star, GBC, Hilroy, Kensington, Leitz, Marbig, Mead, NOBO, Quartet, Rapid, Rexel, Swingline, Tilibra and Wilson Jones. The Company’s ACCO Brands North America and ACCO Brands International design, market, source, manufacture and sell traditional office products, academic supplies and calendar products. ACCO Brands North America consists of the United States and Canada, and ACCO Brands International consists of the rest of the world, primarily Northern Europe, Australia, Brazil and Mexico. Its Computer Products Group designs, sources, distributes, markets and sells accessories for laptop and desktop computers and tablets. ACCO’s current market cap is about $559.2 million.
Earnings and Sales Growth: Over the last twelve months, earnings declined nearly -67%, while sales decreased by about -29%. In the last quarter, earnings improved dramatically by almost 71.5% while revenues were 4.5% lower. ACCO’s operating profile before the pandemic set in was narrow, but generally healthy, but over the last couple of quarters has seen signs of significant deterioration. Over the last twelve months, Net Income was 4.73% of Revenues (versus 6% in the quarter prior) and narrowed to about 1.5% in the last quarter (versus 2% in the quarter prior). This is a sign that the company’s profitability is still being pressured, and could continue to be while the pandemic persists.
Free Cash Flow: ACCO’s free cash flow is very healthy, at a little more than $255.3 million; this marks an improvement from $207 million in the quarter prior. The current number also translates to a very attractive Free Cash Flow Yield of 40%. It is also worth noting that ACCO’s Free Cash Flow was just $40 million in March of 2019, with the company showing consistent improvement in this critical metric from that point. That acts as an interesting, and useful counterpoint to the company’s Net Income story.
Debt to Equity: ACCO has a debt/equity ratio of 1.37. That is a high number that signals the company’s heavy reliance on leverage. Their balance sheet shows $971.4 million in long-term debt versus just about $129 million in cash and liquid assets. For now, the company should be able to service the debt it has; however continued deterioration of Net Income could force the company to extend their debt even further (which management indicates they have the ability to do) – in essence pushing the issue further out in time on the expectation that an eventual improvement in business activity will make up the difference.
Dividend: ACCO pays a dividend of $.26 per share, which translates to an annual yield of 4.36% at the stock’s current price. ACCO differs from many small-cap stocks in that it pays a dividend at all; but under the circumstances, it is uncertain how stable the dividend is.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term target at about $9.98 per share. That suggests the stock is carries a useful discount, being undervalued by about 67% right now.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s downward plunge from its high at around $11.50 in February to the stock’s low point, reached in mid-March at around $3.50. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock rallied by the end of April to the 50% retracement line at around $7.50 before dropping back again, with a second bounce in mid-May providing a new push back to the 50% retracement line that went a little above it in June. In September the stock dropped below support at around $6.50 to find new support about a week ago around $5.50. That puts resistance back at $6.50 (previous support becomes new resistance). A push above $6.50 should see the stock retest its $7.50 levels, with additional upside to around $9 if bullish momentum increases. A drop below $5.50 should find support around $5, with room to fall back to the stock’s bear market low at around $3.50 if bearish momentum accelerates.
Near-term Keys: ACCO has a very attractive value proposition, and some intriguing fundamental strengths that make it a tempting target for a long-term opportunity. The stock’s deteriorating Net Income and questionable liquidity are significant red flags, however, along with management’s own expectation that the challenges they have faced in 2020 are likely to continue for the foreseeable future. I think that depresses the stock’s long-term upside prospects enough to say that the smart approach right now is hold tight. There could be an interesting short-term opportunity to buy the stock or work with call options if it can break above its current resistance at $6.50, with upside to $7.50 at least and possibly into the $9 to $10 range where its “fair value” rests right now. Watch, however for a drop below $5; that could be a signal to consider shorting the stock or working with put options, using a level at around $3.50 as a useful profit target on a bearish trade.