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An Out-of-Consensus Small Cap: Ennis, Inc.

(Guest Commentary - July 20, 2006)

Dear Subscribers and Readers,

For those who had wanted to learn more about picking stocks and evaluating companies, I have again invited our regular guest commentator Mr. Bill Rempel for a quick mid-week discussion of an individual stock that he likes – since this author is currently in the midst of a relocation to Los Angeles from Houston.

As I also mentioned previously, I will bring in another guest commentator for this weekend's commentary.  That guest commentator will be fellow newsletter writer Kirk Lindstrom of http://investment.suite101.com/ and will be giving us an update on his asset allocation and the stocks that he currently likes.  Kirk has had a marvelous investment track record since he began his portfolios at the end of 1998, and is definitely worth listening to.

Newsflash: As I mentioned in a real-time “special alert” to our subscribers on Tuesday morning, we went 50% long in our DJIA Timing System at a DJIA print of 10,770.  With yesterday's surge, that would put us 241.42 points in the black so far.

In this commentary, Bill is going to Ennis, Inc. – an out-of-consensus stock in an out-of-consensus industry.  This is again a “value play” given that Bill is a value investor at heart.  Without further ado, following is biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “Beasley Broadcast Group” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) in back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.


I feel like I'm focusing strictly on small caps recently, but a good portion of the stocks on my value screener tend to be small.  This is probably because the under-analyzed and less-widely-owned stocks are where the most significant long-term mispricing is most prevalent.

Ennis

"From a small, rural company serving the cotton industry to a complete printed products manufacturer, Ennis has always strived to increase the success of our distributors."  Ennis, TX was founded in 1871 and was a railroad town named after a railroad official, Col. Cornelius Ennis.  "In 1930 the community had a population of 7,069 and 205 businesses, including two ice companies, two printing companies, a cottonseed oil company, and a creamery. Ennis remained a predominantly agricultural community, as demonstrated in the chamber of commerce's slogan, "Where Railroads and Cotton Fields Meet.""  One, or possibly both, of those printing companies became the small cap stock that I'm writing about today.  Several of their Texas locations, and their home office, are in towns commonly considered parts of metro Dallas/Fort Worth.

Ennis Inc., previously known as Ennis Business Forms (EBF), sells business forms and apparel in the U.S., although they are now starting to expand internationally.  Their material includes continuous forms, laser cut sheets, tags, labels, integrated products, jumbo rolls, flex-o-graphic printing, advertising specialties, Post-it Notes, internal bank forms, secure and negotiable documents, T-shirts, fleece goods, and other stuff like that.  They're not really a distributor; they're a wholesaler whose focus is on the production and sale.  The apparel segment is recently acquired and that acquisition impacted the stock and financials in recent years.

EBF is a small stock with a market cap of $500 million.  Their P/E of 12.2, forward P/E of 11.6, P/S of 0.9, and P/B of 1.6 all seem to be cheap on an absolute basis.  Other financial metrics of note per Yahoo!Finance are the D/E of 0.35, ROA of 9.1%, and ROE of 14.2%.  There are no analysts making 5-year projections for EBF.  Currently, there is only one analyst predicting earnings and no analysts making revenue projections.

As discussed in my prior commentaries, the P/E ratio can be used to approximate the pricing of growth in earnings versus a discount rate.  Using a very conservative discount rate of 15%, the S&P 500 historical growth rate of 6% produces a "fair" P/E of 11.5, which is not too coincidentally close to what I use as part of a rough screen for value stocks.  Using a less conservative discount rate of 11.5% (the arguable historical total return on stocks), the S&P 500 historical growth rate of 6% produces a "fair" P/E of 18.6.  Given that Ennis has a P/E of 12, the obvious next question is whether its growth prospects justify that P/E.

Ennis ends their fiscal year in February.  The EPS over the last ten years, per MSN Money, looks like this:

Income Statement - 10 Year Summary (in Millions)

  Sales EBIT Depreciation Total Net Income EPS Tax Rate (%)
02/06 559.4 72.3 18.3 40.5 1.58 36.60
02/05 365.4 40.2 11.1 23.0 1.19 38.80
02/04 259.4 29.8 9.3 18.0 1.08 37.60
02/03 240.8 25.6 9.2 15.2 0.93 37.40
02/02 236.9 26.4 10.3 15.0 0.92 38.40
02/01 229.2 23.6 9.7 13.2 0.81 38.90
02/00 166.5 24.0 5.9 15.1 0.93 37.10
02/99 150.9 22.6 5.4 14.1 0.87 37.30
02/98 154.3 15.8 6.2 10.2 0.62 35.70
02/97 153.7 21.6 4.9 13.5 0.82 37.20

Between the years 2004 and 2005 the number of shares outstanding, assets, income, and debt all increased due to a major transaction, the addition of apparel.  However, the EPS shows a fairly steady increase over time.  Over nine years, EPS has increased at a 7.5% annual clip.  From the lows of 1998, it's a 12% annual pace.  For last year, it's a 33% pace.  Business appears to be good.  If one assumes that, instead of the 5 years I typically use for a two-stage model, that EBF can keep up the higher growth for 10 years (it IS a small cap), from this back-of-the-envelope calculation it appears that a P/E of 12.7 is "fair" with a discount of 15%, and a P/E of 20.8 is "fair" with a discount of 11.5%.

Description Mrkt Cap P/E ROE Div Yld LT D/E P/B Net  Mrgn P/FCF
Sector:Consumer Goods 2295B 28.91 19.00 2.34 1.32 19.54 7.61 52.80
Industry: Office Supplies (More Info) 3.6B 21.40 11.60 2.71 0.77 6.73 3.70 113.4
Companies
ACCO Brands Corporation(ABD) 1.0B 20.56 8.43 NA 2.19 2.57 -0.02 -43.7
Banta Corp.(BN) 1.0B 12.03 12.68 1.60 0.14 1.90 3.57 73.77
Ennis Inc.(EBF) 496M 12.11 14.16 3.20 0.35 1.62 7.81 103.4
Courier Corp.(CRRC) 459M 19.93 15.30 1.30 0.00 2.80 7.64 -99.4
Standard Register Co.(SR) 324M 590.5 0.03 8.10 0.20 1.85 0.65 -23.6
Franklin Covey Co.(FC) 131M 19.82 8.16 NA 0.28 1.60 1.61 -16.2
AT Cross Co.(ATX) 74.6M 94.61 1.12 0.00 0.08 1.11 -0.44 350.8
Impreso Inc.(ZCOM) 9.4M NA -12.5 NA 1.00 0.66 -3.82 11.23

By comparison to its peers, Ennis doesn't look all that bad.

Other interesting metrics include a short interest of 1.32 million shares, up from 1.11 million last month, representing 6.4% of the float and 9.7 days to cover.  This stock is closer to its 52-week high than to its 52-week low, which is rare for a stock that looks like value.  That type of value action is more in line with a peaking cyclical like oil stocks or homebuilders through most of 2005.  It certainly is curious ... Ennis has been a net payer of debt ever since the apparel addition, and they haven't been wasting money repurchasing stock or receiving inflows of cash from issuance of stock since then, either.  The last item of interest from the "finance gateway summaries" is the dividend yield.  This stock pays $0.62 annually for about 3.2% yield, which is respectable in my opinion.  Parking some money in a small cap stock with growth potential and yield is somewhat attractive.  The insider ownership of 21% is probably responsible for the high yield ... which represents about 40% of operating cash flow for the past two years.

Here's a table of the financial metrics I calculate, based on MSN Money's tables.

Calculated Fields 2002 2003 2004 2005 TTM
Revenues 241 259 365 559 555
Tangible Book Value 63 76 8 35 43
Net Income 15 18 23 41 41
Operating Cash Flow 23 26 20 47 41
Free Cash Flow 5 25 -90 40 36
Profit Margin [Net Income / Revenue] 6.3% 6.9% 6.3% 7.2% 7.4%
ROA [Net Income / Total Assets] 10.0% 11.7% 4.6% 8.2% 8.3%
ROE [Net Income / Shareholder Equity] 15.7% 16.3% 8.5% 13.6% 13.5%
Earnings Quality [should exceed 1.00] 1.29 1.28 0.93 1.10 0.99
Gross Margin [Gross Operating Profit / Revenue] 30.1% 30.0% 27.9% 28.7% 29.0%
Total Liabilities / OCF 2.46 1.66 11.28 4.16 4.75
Current Liabilities / OCF 1.12 0.97 4.07 1.35 1.66
Interest / [OCF + Interest] 5.4% 3.0% 12.3% 14.9% 16.0%
Intangibles as Percent of Assets 22.4% 22.3% 53.1% 53.0% 52.4%
Inventory as Percent of Sales 5.4% 5.3% 21.9% 15.9% 16.1%
Accounts Receivable as Percent of Sales 13.7% 11.5% 12.8% 7.5% 8.4%
Reliance on Financing Cash [should be negative] -11.2% -13.2% 19.4% -7.1% -5.8%

I find nothing to be alarmed about, and quite a bit to be satisfied with, in the company's metrics.

From a technical perspective, I would think that entry after a new 52-week high (if made) would be the safest bet for a trade.  This is EBF's third attempt at $20 this year, and the last time it penetrated $20 was in 2004 where it fell short from $21.  Depending on how you squint your eyes, you have either three (red) or seven (green) major moves in the last three years.

EBF (Ennis Business Forms, Inc.)

We haven't seen any insider transactions in 2006, and in the last year only chump change has been traded by the insiders.

I find the company structure intriguing.  They place substantial power in the hands of local management as they feel the business is regional in nature.  This also helps them in acquisition negotiations, and a good portion of their growth is due to acquisition, which I generally don't like as much as organic growth, but I recognize that in some industries it's probably the only way to go.  There is no nepotism among the directors and senior officers, who own about 3.3% of the company.

As of this writing, there is no announced earnings date, but they are just about due.

Disclosure: I'm not in this stock as of this writing.  I think it has great credibility as a value stock and potential long-term holder for those so inclined, but I would like to see some movement before buying in.  The dividend yield may make the stock very attractive to those interested primarily in income with growth potential as a side benefit.

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