Whenever I run stock screens to try and find new shares worth investing in, Paypoint always seems to pop up. The company has great Returns on Capital, strong Free-Cash Flows and a Bullet Proof Balance Sheet. But the one thing that has always stopped me from investing in the company is the unknowns about its future i.e. the implications of its business model in a cashless world.
Paypoint is a retail payment processor that allows customers to pay utility bills, buy lottery tickets, top up the credit on a mobile phone and send money to other people via its terminals which are found in local shops. The processor also allows people to pay council house rents.
Do you live in a council house? If so, did you know that you might be entitled to a right to buy mortgage? Right to Buy is a government scheme designed to help tenants in council housing to buy their homes at a discounted rate. Often, the discounts offered can be used against the upfront deposit costs, meaning that those who can afford the mortgage can purchase their property without paying any deposit at all.
That being said, what else do we know about Paypoint?
- Return On Capital Employed (ROCE): Paypoint has consistently produced a lease-adjusted ROCE of above 40% for the last 10 years. This is simply phenomenal. Paypoint is able to generate high returns as it doesn’t require a huge amount of investment in assets compared to the size of its profits. This means that it is capable of making very high returns on investment.
- Free Cash Flow (FCF): Paypoint is a Free Cash Flow producing machine. The FCF per share figure has been trending up over time going from 19 per share to just over 50 per share in the space of 10 years. This again is simply amazing.
Looking at the cash flow margin (free cash flow to the firm as a percentage of turnover) it is trending upwards and currently around 15%. The importance of a high-profit margin is so that a company can withstand a few setbacks in their trading activities much better than those with low margins. This makes these types of companies generally safer investments – providing new competition doesn’t try to grab a slice of those profits.
- Great Balance Sheet: The company’s finances are in great shape with net cash of £56.9 million. It has no borrowings and virtually no hidden debt.
- Great Shareholder returns: As FCF has trending up over time, so has shareholder returns in the form of dividends per share. The company has grown its dividend from 5p a share to around 40p a share in the space of 10 years. This is a compounded growth rate of over 20%!
The one problem from the fast growth rate in dividend increases is that the FCF dividend cover has been trending downwards over the years. This means that the dividend is taking up a bigger chunk of the company’s free cash flow. So although there is no current threat of a dividend cut, the dividend growth rate going forward should be lower than what it has been.
The Problems – Struggling For Growth
With so much going for Paypoint financially, the question of why it is trading at such a low P/E needs to be asked. Paypoint’s lowly valuation is due to many analysts and investors being worried about the company’s inability to grow. Tearing into the financial reports, they do have a point. To keep it short and not to bore you I will only have a brief look at two core segments.
Paypoint’s biggest money-spinner is its Bill and General segment which consists of prepaid energy, bill payments and cash-out services. Over the past year, transactions have fallen from 449.2 m to 430.5 m with revenue also falling from £59.5m to £58.5m. This is particularly worrying as analysts were unsure about what the rollout of smart meters would do to the company’s business. From the information seen so far, the move to smart meters is opening up different ways for prepayment customers to pay their bills – as opposed to cash in their local shop as Paypoint would want
The Top Ups segment includes transactions where consumers can top up their mobile and prepaid debit cards. This segment also appears to be in decline with net revenues falling over 10% in the last seven years. One would expect to see this trend of falling transactions in this segment simply due to the industry dynamics changing. It is natural progress after all.
When looking at PayPoint’s overall net revenue growth across its core business is struggling to grow. The company has tried to capture the growth in internet and mobile payments over the last few years but has not been able to make this business profitable and has decided to sell it. As we enter a new cashless society, one would expect Paypoint’s problems to compound.
Ways The Company Could Grow
With growth being the main concern surrounding the company at present, it is interesting to see what steps management are taking to alleviate this problem.
One area management thinks the company could grow is via the roll-out and implementation of its recently launched PayPoint One terminal which helps retailers with other parts of their business (such as stock control) which in turn will allow it to get more of them on board as customers. Should this platform be a success, you can expect Paypoint to continue to perform well and have high and sticky operating margins. A successful phasing in of this platform will ensure that the decline in the Bill and General segments and the Top-Ups segments is not felt too much by the company. The one thing to note on this however is that the company remains vulnerable to increased competition in payments from services such as Apple Pay and online services. The risk for shareholders is that a new rival product could see its customers go elsewhere.
The company has also diversified by forming a joint venture with the parcels company Yodel to form a company called Collect +. The purpose of this joint venture is to exploit the rapid growth in click and collect services from online retailers. PayPoint retailers are a convenient local place to collect parcels and return unwanted ones and has grown strongly. The Collect + business is making a small profit but PayPoint’s problem is that its partner company Yodel wants to charge more money to shift parcels around the country which will lower the profits of Collect +. It is by no means certain that this business will create a lot of extra value for PayPoint’s shareholders.
One success story Paypoint has had over the past few years is its entry into Romania where cash still accounts for a high proportion of personal spending transactions. If the country were to enter another cash-heavy developing market, it could provide the types of profit and cash flow growth investors are looking for.
Is Paypoint A Good Stock?
This all depends on your view on how fast we move to a cashless society. Going cashless would mean consumers would pay their bills – and other expenditure which they currently use pay point for – online rendering most of the company’s core business useless.
If your view is we are moving to a cashless society quickly, it is probably best to look elsewhere for a worthy investment. On the other hand, if you think cash is here to stay, this is a business that could perhaps interest you. At present, the company is trading at a P/E of 9.6 which is certainly cheap as compared to the overall market. If you expect the company to simply maintain its profit over the next 10 years, then the stock is currently screaming bargain.
When doing a discounted cash flow analysis to work out the intrinsic value for Paypoint’s shares, I get a value of £8.60 a share suggesting shares are currently trading at a discount. Please note that I used analysts’ estimates for future free cash flow and the figures to me seem a little too bullish. Personally I would want a much larger margin of safety to account for the uncertainties surrounding the business and would consider purchasing shares at a lower price.
On the whole, it is fair to say that PayPoint has been an excellent business that has produced excellent returns. The Returns on Capital Employed are high and the balance sheet is rock sock solid. The big problem facing the company is its vulnerability to increased competition in payments technology and this could absolutely shatter its core business.
I am keen to hear your thoughts on Paypoint. Are you a user or retailer who uses it? How do you think the company will fare in the future? Is Paypoint a share you have in your portfolio?