Pollard Banknote is a buy, says Echelon Wealth

Pollard Banknote Limited (Pollard Banknote Limited Stock Quote, News, Chart TSX:PBL) had mixed results in its latest quarter owing to depressed margins, but the drop leads to just a small reduction in target price from analyst Gianluca Tucci of Echelon Wealth Partners, who in a client update on Wednesday reiterated his “Buy” rating while lowering his target from $27.00 to $26.50.

Pollard, a lottery and charitable gaming products and services company which has been a leading supplier of instant tickets for over 30 years, announced its second quarter 2019 financials on Tuesday, where revenues came in at record levels. The growth came from the company’s core lottery business, particularly in the higher ancillary product revenue of its iLottery and digital product lines, according to management, who noted the company’s depressed profitability.

“Our profitability was lower than expected due mainly to a mix of instant ticket sales that was weighted toward lower average selling price and more challenging production. Not only did this reduce our gross margin percentage, it also resulted in our production volumes being slightly lower than we anticipated, notwithstanding increasing orders,” wrote co-CEO John Pollard in a press release.

PBL’s Q2 revenue of $97.1 million was the highest Q2 level in company history and arrived in line with analysts’ expectations — Tucci had estimated $97.3 million whereas the consensus expectation was $97.1 million. On adjusted EBITDA and EPS, PBL generated $13.6 million and $0.20 per share, respectively, in comparison to Tucci’s $16.3 million and $0.24 per share, respectively, and the consensus $15.4 million and $0.20 per share, respectively.

Pollard Banknote margins lighter than the analyst expected

Tucci noted that the company’s gross margin was light at 22.2 per cent versus his estimate of 23.5 per cent, with the miss attributable to the instant ticket sales mix weighted toward lower margin work and resulting in reductions in production efficiencies.

“Gross margin, over time, will continue to be supported from increased instant ticket volumes, ancillary products, and iLottery sales,” writes Tucci. “In Q219, PBL recommissioned its original Ypsilanti press and has recently added some additional equipment in order to increase its capacity. We believe this is indicative of additional volume commitments from its customers and view H219 as further opportunity to further monetize synergies from recently completed acquisitions (International Gamco, Innova Gaming, Schafer Systems, Fastrak Retail) which should further drive free cash flow, profitability, and complementary acquisitions down the road.”

Tucci noted that PBL’s current contract portfolio is holding steady with an average contract term including renewals in excess of four years. Tucci says that PBL will continue to strategically bid on new instant ticket contracts while focusing on growing its portion of work within lotteries with shared supply contracts.

The analyst says that he’s revising his 2019 estimates, now thinking that PBL will generate revenue, adjusted EBITDA and EPS of $393 million, $62 million and $0.91 per share, respectively.

Earlier this year, Pollard completed its acquisition of UK-based ticket dispensing and merchandising company Fastrak Retail for £4 million (Cdn $6,466,880). Tucci says that the pickup will likely generate complimentary synergies with Pollard’s Schafer Systems acquisition, calling the Fastrak deal “positive and strategic in PBL’s efforts in becoming the lottery partner of choice.”

Tucci’s $26.50 target represents a projected 12-month return of 12 per cent at the time of publication