Deluxe's Steady Decline

Today, my inner "yield-pig" is getting the better of me. I spent time digging through some preferred REIT shares this morning, and then I noticed that Deluxe (NYSE: DLX  ) was reporting earnings. Given its 6.2% dividend yield, I just couldn't resist taking a peek.

Deluxe is primarily in the business of selling checks. You remember checks, right? They're the handy bundle of paper forms that banks give to you when you open a checking account so that you can pay your bills.

You say you pay your bills online? Well, a lot of people do these days. To be polite, check usage is "mature." To be accurate, it is in decline. Two questions for Deluxe: How steep is that decline, and can the business the company is developing to service small-business owners grow quickly enough to make up the difference? If Deluxe can execute on its small-business strategy -- and the decline in the check business turns out to be slow and orderly, over a period of many years -- the shares could ultimately be cheap.

Looking at the first quarter's numbers, the small-business-services revenue gain of 4.9% didn't manage to make up for the declines in the other two check-related portions of the business, which declined 19.3% (financial services) and 13.4% (direct checks). Looking at the business from an operating-income perspective, the small-business-services segment actually declined despite the gain in revenues, because the company has reallocated certain expenses to this portion of the business from the check business. I guess that's reasonable, but for the total business, operating income declined 32.5% in the quarter, and that's not good no matter how you rearrange the numbers.

I don't yet have a good handle on the level at which check usage might stabilize, but I do know that my birthday check this year from my grandmother came from an electronic service. And having lived in Japan, I know it's possible for an economy to function quite well without checks. It's not inconceivable to me that checks will go away altogether in the next 10 years. All of this, of course, is giving me fits as I try to determine the value for the declining portion of Deluxe's business.

Last week, the company announced the hiring of a new CEO, Lee Schram, from NCR (NYSE: NCR  ) . The company also announced the resignation of its CFO. That's normally a bad sign, but given the timing of it, I'm inclined to believe this is part of a larger management change. I'm not inclined to believe that new management can change the tide on check usage, but I am willing to pay attention to strategies new management might outline for improving the small-business-services division, as well as possible new endeavors that aren't a huge stretch beyond what the company currently does.

Currently, Deluxe's dividend is well-supported by free cash flow, and the company's guidance for 2006 supports it as well. But until I get a grasp on how much longer that will last, and on the plans outlined by new management, I'm much more likely to turn back toward the REIT-preferred shares I've been eyeing to sate my appetite for some high yields in my portfolio.

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NathanParmelee has no financial interest in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.


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