SupremeX: The dividend check got lost in the mail

SupremeX is a company I’ve been following for a while and I am a long suffering shareholder.  A quick view of the stock chart will show you how bad it’s been. The reason I am talking about it today is because I believe it has hit an inflection point and will start to rise to a more reasonable valuation over the next year or so.

I came across SupremeX through Clarke Inc, an activist shareholder investment company that makes a large investment in struggling firms and tries to turn them around. Before Clarke invested in SupremeX it was a struggling company and Clark turned them around which lead to an impressive share price return. Clark however has long moved onto other things and SupremeX once again has been struggling. Although the company has had a hard time I believe it’s been sold off more than it deserves.

The company has three divisions: Canadian envelopes it’s legacy business, U.S. envelopes as a small but growing business and packaging as it’s new business for growth and diversification. The company controlled about 60% of the Canadian envelope market and then made the acquisition of Royal Envelope in Q1 2020 giving it I think about 80% market share. This business is a cash cow, but a declining one as for obvious reasons envelopes are a thing of the past and sales are on a downward slope. The company’s strategy has been to sell excess production capacity in Canada into the U.S. and to diversify into packaging. Packaging is not as high a margin business as envelopes are, but to survive the company needs to replace lost sales from envelopes and that is a natural business for them to go into as a replacement.

I have to admit, I kind of have a soft spot for companies doing business in old legacy and dying industries. I kind of like the underdog feel to them and think most people don’t give them any respect. Maybe I’m biased, but I feel I want to give SupremeX a chance.

Now how did SupremeX get from a stock price in the $4 – $5 dollar range to where it is now at about $1.30? Well part of that is due to the natural decline in their core envelope business, but the other reasons  I think are temporary. 2019 was a very bad year for them for two reasons. The first was paper prices went through a rapid cost inflation of about 10%. The nature of SupremeX’s business is that they can only raise prices at certain points of the year so there was a margin compression effect caused by raising input costs, but they could only raise their prices a quarter or two later. The second reason 2019 wasn’t too good for them is they had issues integrating and doing growth capex in their packaging businesses. The company has acquired several packaging companies to diversify their business and in 2018/2019 they invested heavily in integrating them and growing their capacity. This lead to down time while factories were moved or upgraded with new equipment and lead to decreased earnings. The plus side is that both these things are now behind them and they have had good earnings in the first half of 2020. They earned about $0.16 of profit giving them a P/E ratio of 8 based on half a year’s earnings alone!

There is one more reason the stock price is down and that is they recently cancelled their dividend. They used to pay out $0.26 per year in dividends, but for three reasons it was cancelled. One is that it was getting close to 100% of earnings. The second was they took on lots of debt for their Royal Envelope acquisition and lastly due to COVID-19.

Combining these three factors the stock price has fallen to a low of $1.12 and is now at about $1.30. All of these factors however are temporary in nature. The cost price inflation issue is behind them and while it could come back ultimately with 80% of the Canadian envelope market they do have pricing power and this won’t be an issue long-term. The acquisition integration and capex issues are also for the most part behind them. They have done the spending they need to and now just need to sell their newly grown capacity. Lastly for their dividend while I don’t think it will come back at the level it was before I do think it will come back within the year at a reduced rate of maybe $0.16 per year or so.

One issue with this company is other than the Jerry Zucker Revocable Trust which owns ~20% of the company the management and board own very few shares of only about ~1%. It would be nice to see more management ownership, but I think this is maybe not too big of an issue. I’ve read all their corporate presentations and listened to all their quarterly conference calls and I like how management thinks. They don’t just think about operating the business, but also think strongly about finance and capital allocation and have a strong focus on shareholder return through dividends and buybacks. They sound like they do want to bring back the dividend, but are just being cautions due to their debt-load and the uncertainty of COVID-19. Unless Canada goes through a crushing second-wave I think the dividend will be back within the year. In the mean time they have announced a share buyback and I believe they will act on it and that is the smartest move for them to do right now. It returns money to shareholders in a way less risky than dividends and takes advantage of the very low stock price right now.

My prediction is we will easily see $2 per share for a 50% return within a year and could even see a doubling of the current share price as a reasonable possibility.

Disclosure: I own shares of (TSE:SXP)

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