Boring Is Beautiful

If there's one area of the stock market that's almost perpetually underappreciated, it's those boring little companies that peddle along, generating impressive cash flow year in and year out, paying dividends, and making unremarkable but consistent steps each year to improve and grow their business. These companies don't issue many press releases, except to announce the usual quarterly profit or declare another dividend. Yet all the while, they quietly compound a fortune for their shareholders.

Ennis (NYSE: EBF  ) is one such company. Over the past five years, Ennis shareholders have been treated to 12% average annual returns (including reinvested dividends) vs. zilch for the S&P 500. Ennis operates in the quintessentially boring industry of printed business products, but offers a fine example of how boring can be beautiful to investors.

A long, profitable history
Ennis was started in 1909, beginning with tags to serve the cotton-farming industry in North Central Texas. In the 1920s, the company introduced printed sales books, expanded into register and multipart forms in the 1950s, and then in the 1960s expanded to provide continuous forms, checks, and carbonless paper products. The company introduced hospital menus and imprinted products in the 1970s, and added business supplies, labels, software-compatible forms and checks, and PC-related printed products in the 1980s and 1990s.

Ennis has grown revenues from $85 million in fiscal 1983 to $259 million last year. While the economics of the business maxed out in the early 1990s, with free cash flow margins above 15% and return on equity north of 30%, Ennis isn't doing too badly today. In fiscal 2004, which ended in February, free cash flow as a percentage of sales was 8.8%, the company generated $22.8 million in free cash flow, and return on equity was 21.4%. These aren't the numbers of a mediocre business.

And by the way, Ennis has a 31-year string of consecutive quarterly dividends, with a current annual payout of $0.62, or about 45% of free cash flow. The remaining cash flow has been used to either repurchase shares or make small acquisitions.

Trustworthy management
In 1997, current Chairman and CEO Keith Walters came on board and began to help Ennis transition into faster-growing areas of printing and printing services, mainly through acquisitions, while slowly growing market share and emphasizing profitability in the mature traditional business forms industry. Walters seems a no-nonsense, tell-it-like-it-is kind of manager.

Walters' letters to shareholders are straightforward and informative, with an emphasis on integrity and responsibility. In the 2002 annual report, Walters noted Ennis' long record of conservative accounting:

Financial reporting is an area that has received an extreme amount of press recently. Ennis is proud to say that we have continued to follow a very conservative approach in our reporting to our shareholders. We continue to accomplish our results without resorting to restructuring charges, an achievement dating back to 1972.

Sensible acquisitions
Ennis' management team has been very deliberate in its capital allocation decisions, striking a healthy balance of maintaining the attractive dividend payout while using the remaining cash to further the long-term strategy of finding faster-growing opportunities outside the core business forms industry.

So far, Ennis has acquired complementary businesses for only single-digit multiples of free cash flow -- paid for primarily with cash. Most recently, Ennis paid $22 million for its Calibrated Forms acquisition, a company with $44 million in annual sales and approximately $7 million in annual free cash flow.

Another successful acquisition was the February 2000 purchase of Northstar Computer Forms, a leading manufacturer of printed products for the banking and financial industry. The purchase price was $44.2 million, which was financed with $36.5 million in bank loans and the rest with cash. In the recently released 2004 annual report, Walters noted, "The [Northstar] acquisition continues to be a success and has now returned in cash flow all of the original debt incurred for the purchase."

In the past, Ennis has always made it a point of discipline to pay down each of its acquisitions before pursuing another one. With the balance sheet now flush with more cash than debt (a feat achieved two quarters ago), the company once again has financial capacity for further acquisitions. But Ennis is in no hurry. As was said in this year's annual report, "We are in discussion with several companies. However, this does not mean that we will conclude these transactions. Ennis has been very careful about the quality of its acquisitions and will continue that policy."

Reasonable executive compensation
Ennis pays its managers very modest salaries, with bonuses based on company performance, especially net earnings, return on capital, and revenue growth. Walters is the highest paid officer at a $600,000 base, while both CFO Harve Cathey and VP Ronald Graham took home less than $300,000 each in salary and bonus. Only one other executive took home more than $100,000 last year.

The proxy statement lists every executive officer in the company whose compensation exceeds $100,000 - a total of four people. This is exceptional for a company with nearly $260 million in revenue and more than 2,200 employees.

As for stock options, over the past five years Ennis has averaged only 90,000 net options granted per year, which is practically immaterial relative to the 16.6 million shares outstanding. The outstanding share count has remained constant over the years -- something rarely seen in this age of stock option excess.

Final thoughts
Ennis has the classic virtues that long-term-oriented value investors like to see: a good business that combines outstanding return on capital with the potential for modest growth; a management team that is conservative, capable, and compensated in a manner conducive to shareholder value; and a market price -- currently around 11 times free cash flow and paying 4% -- that offers investors a good opportunity for value creation.

Guest columnist Matt Richey has been a longtime Fool contributor and is a portfolio manager at Centaur Capital Partners LP, a money management firm based in Dallas, Texas. At press time, Centaur Capital owned shares of Ennis.


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