The stock of CPI Card Group (NASDAQ:PMTS), a micro-cap, payment tech specialist has had a rough ride this year, particularly since May; all in all, on a YTD basis, the stock has lost around a third of its market-cap, even as its peers from the micro-cap space have eked out single-digit returns. In fairness, PMTS wasn’t doing too badly until the Q1 results in May which served as a negative catalyst.
Still A Good Business, Notwithstanding A Potentially Challenging Q2
Much of the sell-off was driven by management’s outlook for Q2 (the results of which will eventually be published at the end of this month), where they categorically stated-” do not expect second-quarter results to be as strong as the first quarter”.
Management was understandably being cautious as they were getting a sense of the after-effects of the regional banking crisis on consumer spending (PMTS consumer base mainly consists of large issuers of debit and credit cards, community banks, fintechs, credit unions, etc.). Q1 results (where topline growth came in at 8%, above management’s FY guidance of mid-single-digit growth) were largely driven by the debit and credit card portfolio and clients were understandably guarded about spending in March/April. However, in recent months we’ve seen a dissipation of the regional banking challenges and whilst Q2 may not set the world alight, we think some of the deferred spending could come back in H2 and aid PMTS’s progress.
Also note that despite flagging a potentially weak Q2, management did not scale down their FY guidance. Crucially, one of the long-standing facets of this business will likely rumble on, not just this year, but next year as well (at least, according to consensus estimates). We’re referring to the concept of operating leverage, which PMTS’s business model has been able to facilitate year-in and year-out, for many years now.
As you can see from the image below, EBITDA growth has always exceeded revenue growth since FY18, and this year management believes EBITDA growth could come in at mid-to-high-single digit growth, even as sales grow at mid-single-digits. Consensus suggests that even though there will be a superior differential between EBITDA growth and sales growth it will not be much, but next year, the differential could expand once again by over 400bps!
A few naysayers of PMTS also worry about the company’s perpetually high debt levels which have stayed at around $300m-$350m since FY15. However, we’d urge some of the critics to not be too myopic about that facet alone and consider some other levers which suggest that the company is not getting bogged down by this, and is doing just fine.
Firstly, look at the progress made on the net leverage ratio which is the level of principal debt and financial obligations after accounting for cash, as a function of the EBITDA of PMTS. Five years back, this stood at a whopping 12.5x; since then, it has compressed by over 4x and is now at only 2.9x as of Q1!
There’s a good chance these net leverage ratios continue to dip (management thinks it could be anywhere between 2.5x-3x by the end of this year) as PMTS’s working capital dynamics are poised to improve this year. In recent periods, the CPI Card Group’s cash conversion cycle has been well above its historical average, and we think that should mean-revert slightly as a more stable supply chain environment brings down investments in working capital.
All in all, management believes that FCF levels this year could double YoY, and that lever too could play a key role in bringing down the leverage.
Anyway, it’s not as though PMTS is struggling to cover its interest bill from all this debt. Compared to the dire-pre-pandemic interest coverage ratio, these days it is a lot more comfortable at nearly 3x.
From a business angle, we’re also enthused by the burgeoning opportunity with contactless cards, which the US was late to enter compared to other regions. Last year, in the US, only 50-60% of cards in circulation were contactless, but PMTS believes this could hit levels of 80% in a couple of years. As the penetration of contactless cards in the US grows, it will likely provide a fillip to PMTS’s overall pricing dynamics, as the tech involved here is more complex, and they could demand a premium for their services.
Closing Thoughts – Stock-Related Considerations
After the sell-off, PMTS’s valuation narrative looks very alluring. The stock is priced at less than 7x P/E, a 36% discount over its long-term average. Also consider that at 7x P/E, you’re likely getting 14% EPS CAGR growth through FY24, implying a compelling PEG (Price-to-earnings-growth) multiple of just 0.5x.
Then, investors fishing for potential mean-reversion opportunities within the micro-cap universe may likely be eyeing PMTS as a suitable candidate. Note that the relative strength ratio of the PMTS stock as a function of the iShares Micro-Cap ETF (IWC) is currently over 50% off the mid-point of the long-term range.
We’ve also been encouraged to note that after dormant insider activity for much of this year, a couple of months back there was some positive interest, with the independent Chair of CPI’s board, buying shares of PMTS stock.
Separately, with PMTS now part of the Russell 3000 Index, there’s also been a lot more interest from the institutional segment, who have increased their stake of PMTS shares by 43% this year.
Nonetheless, when one looks at PMTS’s weekly price imprints, we’re not necessarily convinced that we’ve seen the worst. From last August, until May 2023, the stock had been trending up in the shape of an ascending channel, taking healthy pauses every now and then, However in May we saw a brutal breakdown from the channel boundary, and since then we’ve seen a series of lower-lows (LL), and lower-highs (LH) validating the strength of the bears.
After dropping to the $20 levels, we’ve seen some improvement in the price action in recent weeks, but going forward we’d be looking for two things before we turn constructive.
Firstly, we’d like to see the stock defend those $20 levels if another bout of selling were to take place, and then we’d also like to see a weekly close above the $27 levels. These potential outcomes would bring an end to the series of LLs and LHs and would give us reasonable confidence that we’ve witnessed some intermediate bottom formation.