Multi-Color Corp. (LABL)

Multi-Color recently announced that it has completed the sale of its Quick Pak unit for 19.2 million. While Quick Pack had gross margins for the year ended 2007 of around 13%, with gross profits at 3.5 million, I do not see this as an accurate reflection of the true profitability of the segment. First, if Quick Pak were a stand alone company actual earnings after general and administrative costs would have been considerably lower. Also in 2006 Quick Pak only posted 5% gross margins. Further in the most recent quarter the segment actually posted a loss. Considering the company only paid 6.5 million for Quick Pak in 2002, coupled with the 18 million in gross profits generated over the 5 ½ year ownership period, I think Mult-Color made off quite well. The timing of this deal comes after the company had paid of the last of its debt. The company is now debt free and has a cash balance for the first time in over 10 years. The company indicated in the latest quarterly report that it is expecting to spend 10-15 million in capital expenditures(CAPEX) this year. This is much higher than the 4.14 million average over the past five years. I see this years CAPEX as a cyclical update of equipment and infrastructure, management indicated that this would not be the normal level of CAPEX. Overall I like the Quick Pak sale, it should lead to improved margins while freeing up cash for updates to equipment which will further the companies competitive advantages.

The Big Picture:

Multi-Color looks to label the world. Multi-Color makes decorative labels for consumer products. This specialized approach to the highly fragmented printing industry accompanied by a highly selective acquisition strategy and meticulous cost savings has lead to growth well above the industry average. Finding a direct competitor to compare Multi-Color to is hard to find. There are no other publicly traded pure play label makers. According to company management, Multi-Color is a very small player even in the label industry were most companies are private or part of a much broader printing company. The company has used its small size to its advantage. Multi-Color acquires very small label operations that larger competitors would not be interested in. To date the largest acquisition was North Star Printing Group in 2004 for 25 million. This small ball strategy has been very lucrative for the company due to diligence by management in acquiring profitable businesses at fair prices. North Star was cash flow positive in its first full year with the company and debt incurred due to the acquisition has been paid off.

While the company has been historically successful with its acquisitions, future growth is highly dependent on continuing to find profitable operations at a price that is cheap. As the company gets larger they will have to start making larger acquisitions therefore drawing more larger competitors that may bid up the price. Right now the company is getting 10% organic growth, but I do not believe this to be sustainable. With no acquisitions I see organic growth at 5% or less annually.

The company is unmoated, but is aspiring to moat itself. In fact, the company already has significant competitive advantages. One of these advantages is that many of the company’s presses and techniques are not available by anyone else in the United States. Also the company prides itself on its customer service. When a client hires Multi-Color for labels, Multi-Color will work with the packager and client and make the process smoother and less labor intensive for clients. The biggest advantage the company has, in my view, is its history in the business and its long standing relationship with Procter and Gamble. Multi- Color has been in the label business since 1918, and had a relationship with P&G for over 20 years. The company can leverage the impressive portfolio it has built with P&G to gain new customers.

The reliance on big customers, while one of the companies best advantages, is potentially the biggest risk the company faces. Significant losses of sales to one of the three companies that make up nearly 60% of its sales would be quite dilutive to cash flow and margins. Multi-Color gets about 30% of sales from P&G , 17% of sales from Miller Brewing, and 10% from Limited Brands (presumably Bath and Body Works).

What it is worth:

I am placing my intrinsic value at $72 a share. This is based on a discounted cash flow model. I assume 10% cash flow growth this year (excluding the Quick Pak deal and excess CAPEX). I assume 10% cash flow growth until 2013 excluding 2009 and 2011 when I factored in a 10% decrease in cash flows due to assumed acquisitions. These growth estimates are much lower than analyst estimates of 17%, but I find them more realistic. I use an 11% discount to future cash flows to account for the small size of the company and the low margins of its business. The growth I assume is dependent on acquisitions. Without acquisitions I would assume 10% growth this year and 5% or less for the next 9, putting my new fair value at around $63 dollars a share. Conversely if the company were to achieve 17% growth, as the analysts project, over the next five years the Fair value would be $127 a share. If the company were to make a bad acquisition of significant scale intrinsic value could be nearly bottomless.