The Stock

What to Buy: The DATA Group Income Fund (TSX: DGI-U, OTC: DGPIF) < USD6.70

Why Now: Management eviscerated the payout when it clarified The DATA Group’s post-2010 distribution policy back in November. A conservatively run document management outfit that now aspires to web-enabled marketing greatness, the Group accumulated a large cash reserve even as the economy around it collapsed in 2008 and into 2009.

Conditions have stabilized, and a new group of senior leaders is set to carry the company into the 21st century with a new strategy that integrates existing talent and capabilities with new methods of reaching potential prospects for customers. A long-term, consistent program of cost cutting leaves the company lean and able to respond to all kinds of unexpected externalities, negative as well as positive. Ample cash and a relatively clean balance sheet mean DATA Group can make acquisitions that further its long-term growth strategy.

We’re looking for a return trip to somewhere in the USD8 to USD9 neighborhood, a move that would likely be triggered by success on an ambitious transition program and a subsequent distribution hike. But even after a 44 percent cut to its distribution, it still yields 10.5 percent.

The Story

It’s one thing to articulate a “web strategy,” quite another accomplishment altogether to execute one. It’s particularly difficult for companies accustomed to a print world to effect a transition that’s nothing less than life-extending.

The DATA Group Income Fund has had to confront assaults on the core of existence while dealing with other threats such as the government flip-flop on trust taxation and the worst economic meltdown in 80 years. Conservative management left it able to survive recent turbulence and new leaders could help the company thrive as the North American economy approaches normalcy.

But best of all, The DATA Group has chosen to remain an income trust.

Roger: We’ve been to Canada for the last two BIG picks. Are you sure you want to go there again?

David: Canada’s where it all began. And, more important than locale, making an investment decision is about buying a business, whether you’re making a move that’ll help build long-term wealth or allocating a little risk capital.

Roger: I couldn’t have said it better myself. So let’s get down to this business: The DATA Group Income Fund (TSX: DGI-U, OTC: DGPIF), a Canadian income trust that hasn’t made it into the Canadian Edge How They Rate coverage universe.

David: It’s a small one, with a market cap of less than CAD200 million. And like a lot of our foreign-based recommendations it doesn’t do a ton of volume in the US. But a competent broker can buy it using the over-the-counter (OTC) symbol–the really competent will execute on the Toronto Stock Exchange (TSX), for a reasonable commission. And the business isn’t particularly exciting: The DATA Group provides “document management solutions, with growing capabilities in direct marketing and specialized print products.”

Roger: I know one thing it does a lot of, and that’s print lottery tickets; that accounts for 5 to 7 percent of revenue, according to my reading.

David: Yes, lottery tickets do make up a big chunk of revenue. And that operation works in strange ways, such as the fact that from quarter to quarter print runs vary based on whether the sponsoring agency is issuing higher-value tickets.

The core of the business is something that most people would rather just forget about, and that’s exactly why the Group has a business: It captures, stores, centralizes and retrieves, according to customer needs, invoices, contracts and other documents essential to sustaining a business.

Roger: It sounds to me as though The DATA Group is probably leveraged to broader, macroeconomic factors.

David: That’s a point management conceded during the first-quarter conference call, that its fortunes basically rise and fall with what’s happening in the economy.

Here are the basics. The DATA Group has been around since 1959 and has built a market-leading position in Canada. It operates a multitude of facilities in 11 regions. Most of its revenue is generated by the DATA East and DATA West segment, which provides business forms, labels, direct mail products, security documents, commercial printing services and facility and print management. It also prints tickets for big events such as concerts. The other segment, Multiple Pakfold, sells forms and labels to independent resellers in Canada.

Roger: From what I read in the first-quarter report things seem to be stabilizing. Although revenue declined 1.5 percent (to CAD84.3 million), it came down at a slower pace than in the fourth quarter. Revenue for DATA East and DATA West (CAD81.6 million) was down 1.5 percent.

Cash available for distribution was CAD5 million, or CAD0.214 per unit, while total distributions declared in the first quarter were CAD3.8 million, or CAD0.162 per unit. The payout ratio was 76.1 percent. That’s a drastic improvement from the 100 percent-plus figures registered in all four quarters of 2010. But of course it reflects a 44 percent distribution cut.

David: The thing about management’s cut in November 2010 is that it was one big move; it pulled out the tooth and took the pain rather than take half measures. It was aggressive, but it leaves them room on the balance sheet to pursue acquisitions that will help it achieve some of the goals included in the three-part strategic initiative management’s been playing up since the fourth quarter.

Roger: It’s important to note, too, that first-quarter distributions were funded entirely by operations.

David: The distribution, since the company became an income trust in 2005, has been relatively consistent. There was only one cut, from CAD1.15872 per unit annualized to CAD0.6504 a share per year, and it was timed to coincide with the implementation of entity-level taxation on specified investment flow-throughs (SIFT). DATA paid CAD0.09375 per unit per month from March 2005 to August 2005, then paid CAD0.09656 from September 2005 to January 2011.

Roger: And the board of directors sees no economic benefits in converting from SIFT to corporation before 2013. (Rules in place allow SIFTs to convert without triggering negative tax consequences for investors and the trust before the end of 2012.)

Let’s get back to what management is doing to get the company moving again. You’ve alluded to “three key initiatives.”

David: “…an aggressive sales effort in core markets of document management services, and marketing related print to generate new business; accelerated development of new products and services to provide enhanced value to customers and new revenue streams; and incremental cost savings.” I’d say much of this remains aspiration, but the company did just go through a pretty thorough reordering of management assignments, including promoting the current CEO from in house back in October, elevating three high performers into senior roles and bringing in two outsiders for senior-level positions and sacking two other senior managers.

During the first-quarter call the new CEO actually noted that the company added five “significant new clients” during the quarter, while losing none. He attributed at least a part of these successes to reordering senior sales management, particularly installing a new VP of sales for DATA East and a new VP of sales for Ontario. New reporting tools and changes to compensation also helped.

Roger: And we should begin to see actual performance on these new fronts in the second and third quarters. Much of the company’s growth–like with Yellow Media Inc (TSX: YLO, OTC: YLWPF)–is tied to its ability to establish an Internet presence. Specifically, management would like to boost its digital one-to-one marketing capability to complement existing marketing services such as direct mail, gift cards and other print and logistics services.

In the second quarter the company will initiate a web-to-print offering that’s designed to capture some of the “digital photo book” market; it’s a new venture for DATA, but digital photo books as a market, according to management, is growing at a double-digit compound annual rate in North America.

And in the third quarter DATA will begin offering a marketing service that integrates print and digital efforts, including building promotional web pages around web campaigns, reaching out via e-mail as well as text messaging, and providing the analytical tools to measure whether it’s all worth customers’ while.

David: I was hoping you would simply point out that the first-quarter 2010 payout ratio was 126.8 percent, and that the fact that it came all the way down to 76.1 percent was reason enough to jump aboard.

Roger: It’s never that easy.

David: Nor should it be. And I’m happy you were able to dig in that deep.

Roger: I dug in deep enough to find this exchange during the call…well, maybe not deep. At any rate the very first questioner following management’s presentation asked for a 2012 revenue growth forecast. Although she didn’t get a straight answer, CEO Michael Suksi did agree with her ballpark guesstimate of low-single digit growth; he specifically said, “We’re not thinking of double-digit growth.”

That’s terribly unexciting.

David: Agreed. But, like last month’s pick, Superior Plus Corp (TSX: SPB, OTC: SUUIF), the market has left this one beaten because it did essentially the right thing, that is aligning its policies in the interest of long-term sustainability.

The types of strategic initiatives the company wants to do don’t require a lot of capital; much of it involves re-deploying existing human assets, perhaps identifying and integrating new software systems, but these are near term expenses that have long-run benefits. The company is “actively involved” in acquisition talks–in terms of size, DATA wants to be involved in deals for companies with CAD10 million to CAD50 million in revenue–but will only move if a deal is immediately accretive.

So, yes, it’s an aggressive yield attached to a boring operation.

Roger: I see the amount outstanding on its revolving bank facilities declined from CAD69 million to 54 million over the last 12 months, and management will leave its lines alone, save for an acquisition.

David: The five new customer wins during the first quarter are important, judging from the manner in which Mr. Suksi described them while answering a question from an analyst. He said the five wins are consistent with the “strategy” management described–the three major initiatives–and that these new customers come from the marketing side as opposed to the old-school document management side of the business, with an emphasis on the digital and web-to-print aspects of DATA’s marketing offerings.

DATA’s new marketing service would enable a customer to customize, for example, each individual piece of mail in a large-run direct mail campaign. You could make different offers to different people based on information you’re able to gather about their proclivities. That’s another element, too, that DATA hopes to provide: the kind of information that will help customers make those types of discrete calls on how to mail.

And “web-to-print” would allow customers to make these types of changes themselves via an Internet-based interface–basically type in changes, upload to DATA’s server and push “print.” Customers are free to create their own art and words and make various combinations thereof–and send the results to mailing lists it can specify from a broader group.

Roger: Only one Bay Street analyst in Bloomberg’s database covers the stock. TD Newcrest has a “buy” rating with a CAD8 target price for the stock, which it maintained following DATA’s first-quarter report.

David: Another thing that stood out to me–for whatever it’s worth–is that the new CEO’s tone during the recent conference call was much different from his predecessor’s Eeyore-like “more of the same” forecast made during the first-quarter 2010 reporting period.

Management is both conservative and realistic in its assessment of what the rest of 2011 holds in store, but it also has considerable ambitions for what it would like its people to do with the business.

Roger: This is a bet on management’s ability to reorient the company, and it’s also an expression of confidence in the direction of the North American economy. Strictly from a DATA perspective, the effectiveness of its strategic initiatives will be revealed in gross margin growth; management is looking for north of 30 percent.

David: This is a nice way to lock in 10 percent-plus with legitimate potential for dividend growth and capital appreciation that goes with it. I’d pay up to USD6.70–at which point, based on today’s conversion rate, DATA’s CAD0.0542 per unit per month distribution would still equate to a 10 percent yield–for a chance to ride this one back up the mid-USD8s.

Roger: Sold. Buy The Data Group Income Fund up to USD6.70 and lock in another double-digit yield.

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• TODAY: The DATA Group Income Fund (TSX: DGI-U, OTC: DGPIF)–Buy < USD6.70