Delightful Discount or Devilish Decline?

Is there anything more ghoulishly frightening than a business in decline? Not usually. But remember that in some of the best scary stories there are riches waiting in crypts. Remember The Mummy? His tomb was a treasure trove. And so it can be with companies. Some firms have been so thoroughly mistreated by the stock market that their businesses are trading for $0.50 on the dollar. That had been my opinion of Deluxe Corporation (NYSE: DLX  ) . Now I'm not so sure.

Yesterday, Deluxe reported that sales rose 50% over last year to $485 million, while earnings were down slightly at $57.5 million. Diluted per-stub income at $1.14 was higher by 5%, due mostly to share buybacks performed earlier in the year. Margins are also declining, and management expects pricing pressure to continue.

But that may not be the biggest problem with Deluxe, as a reader pointed out to me when I last wrote about the company. He called the firm a net destroyer of shareholder value that was egregiously using debt to buy back shares, and he said that I, uh, missed the point in failing to raise these concerns.

Much as I hate to admit it, there's some truth to these criticisms. Although its recent acquisition of New England Business Service boost sales in its only growing segment -- business services -- the price of the deal is reflected on the balance sheet. Total debt has ballooned 118% since last December, to $1.3 billion from $595 million. In an interview this morning, investor relations chief Stuart Alexander explained that more than 95% of the increase was attributed to the acquisition. Still, that leaves potentially more than $35 million for other purposes. The cash flow statement shows $27 million used for share buybacks.

And then there's the issue of shareholder equity. Calculated as the difference between assets and liabilities, or the net worth, of a company, shareholders' equity represents what's left for the owners after creditors get their cut. Deluxe, however, has been running a deficit. That's right, there's not even a scrap left for the stockholders. And the gap is up 155% from the same period a year ago.

Still, there's a bit to like about Deluxe. The company returns some of its income to owners in the way of a market-beating annual dividend of 3.9%, which is easily paid through existing cash flow. I also enjoy management's candor and that they expense stock-based compensation. There's no pretense, either. Deluxe will invest in acquisitions and buy back shares to fuel growth because, frankly, it has no other choice.

Yet it's a spooky time for Deluxe and its shareholders. With debt rising, margins declining, and earnings eroding, the company appears to be one of the walking dead. If you're a value hunter and happen through this graveyard, you'd best have your crucifix and garlic at the ready.

For related Foolishness:

Philip Durell knows the difference between permanent decline and deep value. He regularly shops the bargain bins for out-of-favor businesses for subscribers of hisMotley Fool Inside Valuenewsletter. A free, 30-day trial is yours for the asking.

Motley Fool contributor Tim Beyers doesn't write checks. His wife won't let him. You can view Tim's Fool profile and stock holdings here.


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