It is in the midst of a turnaround that could generate value for investors. It is not a sexy story, and that has left it under covered. Often in those circumstances, investors can find an opportunity, and a company’s share price that does not reflect the value. If Diebold can continue to execute on cost cutting measure, identify growth opportunities and improve its long-term FCF generate, it can generate value for shareholders
Diebold is in the Middle Stages of a Turn Around
In its August update management noted that it remains on track with the turnaround. The company is working to cut costs and establish a performance based culture. It needs to better capitalize on its leading market position and large customer base. In addition, secular trends on the transformation of how branches are organized and outsourcing can drive above average sales growth.
Diebold is primarily in the ATM business and it accounts for slightly over three-quarters of sales. Service of the ATMs generates a larger portion of sales versus product. This is important because service sales remain stable even when customers cut capex. At times, aftermarket/service work can increase with customers opting to repair versus replace. For most companies, aftermarket/service revenue carries a higher margin than OEM business. Geographically, about 50% of sales are in North America with Asia-Pac the next largest portion at 17%.
Sales at Diebold peaked in 2008 at $3.1 billion and have shifted around in a range of $2.7 billion to $3 billion since. Orders were up by 9% in 2Q14 in constant currency. The company is focused on operational improvements. In its most recent update, management stated that it is on track for $150 million in cost savings. Through 2Q14, it realized $20 million of the $25 million expected in 2014. It expects another $20 million in net savings in 2015.
Also, Diebold has made progress on partnerships with Oracle/Infosys and Accenture for IT and back office transformation. Diebold also increased its sales coverage for electronic security and hired other new talent across the organization. It also acquired Cryptera and divested Eras to rationalize its portfolio.
Working Capital Management Improved: FCF has suffered and declined since 2009 but it did stabilize in 2013. In 2014, management is forecasting FCF in the $80-$100 million range due to an increase of $35 million in capex. Despite the decline in FCF, it successfully reduced the cash conversion cycle from 84 days in 2009 to 64 days in 2013.
Gross Margins are improving: Services gross margins are up 650bp since 2009. In 1H14, the Services gross margin was 29.7% versus 27% in 2013. Management’s current target is a Services business with over a 30% gross margin. As a result of the improvements, 1H14 non-GAAP operating profit increased to $75.2 million from $33.9 million.
Investing in Innovation & Acquisitions: Diebold recently acquired Cryptera to add to its intellectual property portfolio. Cryptera manufactures pin pads for ATM’s and other equipment that requires secure pins. Diebold recently improved its design to make skimming more difficult. Skimming at ATMs has a global cost of around $2billion according to the industry. Further innovations can continue to improve Diebold’s product portfolio.
Branch Transformation, Emerging Markets & Outsourcing all Positive Trends
The addressable market for Diebold is growing outside the core ATM business. Emerging markets and especially managed services/outsourcing of ATM service is the biggest opportunity. It is expected to for from $3.5 billion in 2013 to $5.7 billion in 2017. It is critical for Diebold to find growth drivers since many of its markets are mature. Currently only around 15% of ATM services are outsourced. It IT for example almost 70% are outsourced. The following chart provides some scope on the outsourcing opportunity for Diebold.
Diebold expects branch transformations to drive sales of its in-lobby terminals. Banks are cutting both size and staff but actually looking to increase the number of service locations. It’s in lobby ATM can handle 90% of transactions done by a physical teller versus around 60% with traditional ATMs.
The emerging markets opportunity is also substantial for Diebold. Sales from Europe, the Middle East and Africa increased by 40% in 2Q14. Asia-Pac was up by 29% in constant currency. Emerging markets account for 65% of the global ATM installed base, and the ATM market in emerging markets has a 10% CAGR. Trends in those regions can contribute to above average sales growth, and Diebold can take advantage of this position.
A key challenge in emerging markets is actually reliable power. Diebold’s technology is the leader in power management and it produces the most energy efficient ATM and it can run on battery, solar or off the power grid. It continues to improve and add to its product offering in this area.
Electronic Security Market Increasingly Important
Diebold’s sales have shifted towards electronic from physical security. The following chart details this over recent years. Diebold has increased, its sales headcount by 50% in the electronic part of the business to better capitalize on this market. Management believes it is best positioned to focus on National and Regional accounts along with some Enterprise level integrations and larger local commercial accounts. The total addressable market by Diebold in electronic security is estimate at $9 billion. It will not go after the residential markets where the number of competitors is much larger.
Steady Yield and Room for Growing Dividend
Management plans to continue to grow the dividend, and it is targeting a payout ratio of 35% of non-GAAP after-tax earnings. The current estimate dividend yield for 2014 is 3%.
Management expects a mid-single digit increase in sales and EPS in the range of $1.65 – $1.85. FCF is forecast in the $80 million – $100 million range.
Diebold’s cost cutting plans are the keys to its success. Its primary competitor is NCR. NCR has higher margins in its services business compared to Diebold. Diebold’s geographic footprint is particarly responsible as well as a low-margin business in Brazil. The cost cutting measures can drive margin improvement, lead to EPS growth, and potentially push the shares higher. In addition, other opportunities in emerging markets, increased outsources, in electronic security, and through expansion of in-branch ATMs can drive growth at Diebold. Diebold trades at 10.3x TTM EV/EBITDA and 17x FY15 EPS. That is not expensive versus its historic 10 year ranges but not cheap either.