Short Sellers are Going to be Stamped Out
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Pitney Bowes (NYSE: PBI) is a stock that gets a lot of attention for all the wrong reasons. The company is a target of short sellers, with 31% of shares sold short. Most short sellers would say their two reasons to short the stock are: the slow decay of physical mail delivery, and the company's $3.6 billion in long-term debt. Unlike many other shorted stocks, Pitney Bowes pays a very high dividend yield. At today's prices, the yield on the stock is over 10%. Something you don't usually see in a highly shorted stock is the title of dividend aristocrat. Pitney Bowes is firmly in this club with over 25 straight years of dividend increases, including an increase in 2012. With heavy short interest, a high yield, and consistent dividend increases, something sounds out of place. Let's see if this is the next big dividend blowup, or if it's the short sellers who are going to be stamped out.
First, let's clarify that Pitney Bowes isn't just a postage and machinery company. The company actually offers multiple solutions that have very little to do with physical mail delivery. For instance, did you know that Pitney Bowes offers printers? It makes sense when you think about it, here is a company that for over 90 years has been handling the postage printing needs of customers, why not produce your own printers? Granted this puts Pitney Bowes in competition with the big boys in the printing field, like Xerox (NYSE: XRX) and Hewlett-Packard (NYSE: HPQ), but it does give the company a chance at a more diverse revenue stream. If Hewlett-Packard's over 25% gross margin and Xerox's over 35% gross margin are any indication, the one concern would be margin compression. Pitney Bowes currently sports a gross margin of over 55%. However, this margin compression from printers could be offset by the company's software offerings which are traditionally high margin businesses.
On the software side of the house, Pitney Bowes offers 16 different categories of software solutions. While you would expect solutions related to postage, the company also offers solutions for analytics, marketing, data management, and more. Third, the company is in the services business. Pitney Bowes offers document solutions, consulting, and e-commerce. Of course these software and services bring additional competitors to the table such as Siemens (NYSE: SI) and if you are talking databases you have to mention Oracle (NASDAQ: ORCL) as well. Both of these software competitors are growing faster than Pitney Bowes. Oracle is expected to grow EPS by 8.6%, and Siemens is expected to show over 14% growth. If Pitney Bowes is even marginally successful in their software offerings this could give a boost to the company's growth prospects going forward. As proof that the company is a serious competitor in this field, they recently signed a deal to provide some analytics and software solutions to Facebook. You don't get work from one of the most disruptive forces in social media, if you are not bringing top notch capabilities to the table.
The point is, Pitney Bowes makes a lot of money from shipping and postage, but this is not a one trick pony. While Pitney Bowes may never own the database market in the way that Oracle does, and the company may never compete for printers on the large scale that Xerox and Hewlett-Packard do, that's not the point. All Pitney Bowes has to do is be competitive, even minor success in these other divisions would give the company revenue diversification. Let's be blunt though, if you are considering buying Pitney Bowes, you are looking at their dividend.
When it comes to paying a dividend, the only number that makes sense to start with is the free cash flow payout ratio. In short, if a company doesn't have the free cash flow to cover their dividend, it's probably not worth researching much further. Pitney Bowes free cash flow payout has ranged from 38% to 48% in the last three years. The company expects free cash flow for 2012 to come in at $700 to $800 million which would indicate a payout ratio for 2012 of at most 43%. Short-sellers take note, a 43% worst-case scenario payout ratio is not a company to bet against. So it's pretty clear the company can afford its current payout, but can the company keep its dividend aristocrat status?
For 2012 the company has already increased the dividend. To borrow a phrase from Peter Lynch, it's rare that a company increase their dividend if they are in trouble. Now granted Pitney Bowes isn't going to win an award for the most impressive dividend growth. In the last five years the company has averaged an increase of 2.6%. In the most recent three years, this rate of increase has dropped to just over 1.3%. Given what we've seen from the low payout ratio, it seems very likely these increases will continue. So what should investors expect in the future?
To be honest, investors should be very happy with the current dividend and if they get 1-2% increases that is just icing on the 10% dividend cake. Analysts are calling for Pitney Bowes to turn its growth in EPS around from -4.5% over the last few years to positive 6.7% growth going forward. A big part of the company's earnings struggles has been the unwillingness of small to medium sized businesses to invest in newer mail sorting and postage machinery. If the economy improves over the next few years, it seems reasonable that some of these companies will take the plunge into newer machinery to try and capture cost efficiencies. If Pitney Bowes can continue to invest in other areas such as printers, software solutions, and services, short-sellers could be in for a world of hurt. Selling a stock short that pays a 10%+ dividend has to be painful enough, if that company starts to grow, a short squeeze is likely. I'm willing to bet that PBI outperforms the indexes to the point I'm adding a long-term outperform rating on My CAPS today. As soon as The Fool's trading rules allow it, I'm considering initiating a real money position as well.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.