Pick Up 6.6% YTM with Quad Graphics, Bonds Maturing May 2022

  • Net sales for full-year 2018 and for Q4 2018, both increased 1.5% over the previous year period.
  • Over the past two years, the company’s transformation plan has delivered an additional $300 million in incremental, new revenue.
  • For Q4, the company had an interest coverage ratio of 2.4x.

This week, Durig Capital reviews a traditional print-based marketing company that is undergoing a transformation. Quad Graphics (recently rebranded to just Quad) is in the midst of implementing its Quad Transformation 3.0 plan. This plan is helping to add core marketing expertise to the company’s service offerings. This has been accomplished mainly through acquisitions. The company’s most recent financial results show some of the progress on this plan.

As our world moves increasingly towards digital media, Quad is looking to make that transition as well. It has made smart acquisitions over the past twelve to eighteen months that have filled in its areas of marketing and creative expertise. As several of these additions are fairly new, the company is anticipating the full benefits of those acquisitions in 2019 and 2020. The company’s short-term 2022 maturity bonds are currently trading just above par, with a yield-to-maturity of about 6.6%. With this competitive yield and the opportunity to diversify into the print and digital media space, these bonds make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown below.

Fourth Quarter and Full Year 2018 Results

Quad Graphics, recently rebranded as Quad, recently released its results for its fourth quarter and full year 2018. The company spent a majority of 2018 making significant long-term investments in diversifying and growing its revenue streams. These long-term investments will start to yield significant benefits in 2019 and beyond. For 2018, the company’s ongoing transformation did register some wins.

  • Full-year net sales of $4.2 billion represented an increase of 1.5% over 2017.
  • Fourth quarter net sales also increased 1.5% year-over-year, coming in at $1.2 billion.
  • For the full year 2018, net cash provided by operating activities was $261 million, and free cash flow for the year was $164 million.

Over the past two years, the company’s Quad 3.0 Transformation plan has delivered over $300 million in incremental new revenue. Commenting on the company’s 2018 performance, Joel Quadracci, Quad Chairman, President and CEO said, “2018 was a truly pivotal year in our Quad 3.0 transformation. Our fourth quarter performance reflects our continued focus to execute on our strategic priorities to ensure the long-term growth of our company as a marketing solutions partner.”

About the Issuer

Quad (NYSE: QUAD) is a worldwide marketing solutions partner dedicated to creating a better way for its clients through a data-driven, integrated marketing platform that helps clients reduce complexity, increase efficiency and enhance marketing spend effectiveness. Quad provides its clients with unmatched scale for client on-site services and expanded subject expertise in marketing strategy, creative solutions, media deployment and marketing management services. With a client-centric approach that drives its expanded offering, combined with leading-edge technology and single-source simplicity, Quad believes it has the resources and knowledge to help a wide variety of clients in multiple vertical industries, including retail, publishing and healthcare. Quad has multiple locations throughout North America, South America and Europe, and strategic partnerships in Asia and other parts of the world.

Reinventing Quad

A few years ago, Quad began focusing on remaking itself. As a traditional print-based marketing firm, the company’s management saw the changing face of marketing, realizing that much of it was moving to different types of media, much of it electronic. In the wake of that realization, management defined a transformation plan that would refresh the company’s image as well as provide diversified revenue streams outside of the traditional printed marketing media. The plan, known as Quad Transformation 3.0, was detailed by the company’s CEO in July 2017.

“Quad/Graphics continues its transformation to create significant value for its clients by addressing their urgent business needs to improve process efficiencies and marketing spend effectiveness,” Quadracci said. “We refer to our transformation as Quad 3.0, which reflects our evolution from a startup printer that grew rapidly through greenfield growth in 1.0, to a disciplined industry consolidator in 2.0 and now, in Quad 3.0, to a global marketing services provider leveraging a strong print foundation in combination with its deep expertise in workflow re-engineering and optimization, content management and personalized, cross-channel marketing.”

Transformation Via Acquisition

In order to broaden the service and expertise it could offer to clients, Quad has smartly acquired companies that complement the services it was already offering. In 2018 and early 2019, the company has made the following acquisitions.

  • Ivie and Associates: This acquisition expanded the company’s scale for onsite marketing services and subject matter expertise in digital, media and creative services.
  • Increased its investment to a majority investment in Rise Interactive: Rise is a digital marketing agency specializing in digital media, analytics, and customer experience.
  • Periscope: Acquiring in January 2019, Periscope is one of the nation’s top five independent creative agencies by annual revenue. The company has annual revenues of $60 million.
  • LSC Communications: LSC is a global leader in print and digital solutions. Quad expects that this transaction will close mid-2019, pending approval from the U.S. Justice Department.


Decreasing Debt / Extending Maturities

Also in 2018, Quad was able to reduce its debt levels by $24 million. In addition, the company recently completed a successful amendment and extension of its debt facilities. The company intends to use the proceeds for the pending LSC acquisition and to refinance LSC’s existing debt. The following graphic sums up these changes.


Interest Coverage and Liquidity

For bondholders, the interest coverage ratio is a litmus test to indicate how comfortable the issuer is with paying on its existing debt. For its most recent quarter (Q4), Quad had operating income (without the effect of non-cash depreciation) of $46.5 million, and interest expense of $19.3 million, for an interest coverage ratio of 2.4x. In terms of liquidity, the company has $691 million available on its revolver and an additional $69.5 million in cash (as of December 31, 2018).


The risk for bondholders is whether Quad can continue to combat the declines in print marketing and replace them with higher margin services. The company has made some shrewd acquisitions in order to add expertise where it was lacking. And its Transformation 3.0 plan has already delivered an additional $300 million in additional revenues over the past two years. Based on these events, it does appear the about 6.6% yield to maturity on Quad’s 2022 bonds outweighs the risks identified.

In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.


Summary and Conclusion

Quad has seen the writing on the wall. As more and more of our modern world goes digital, Quad has been working diligently to transform itself into a company that not only offers its traditional print based marketing products, but can also address customers needs for digital marketing services, analytics and even creative marketing services. The full effect of its recent acquisitions remains to be fully realized, especially its pending acquisition of LSC Communications. With its Transformation 3.0 plan already registering $300 million in additional revenue over the past two years, Quad appears to be on the right track. The company’s 2022 bonds are couponed at 7.0% and have a yield-to-maturity of about 6.6%. Although this yield is lower than some of the more recent bond issues reviewed by Durig Capital, it is still very competitive when compared to a comparable U.S. Treasury yield. In addition, this is an excellent industry to provide additional portfolio diversification. In light of these factors, these short-maturity, 25-month bonds make an excellent addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.

Issuer: Quad Graphics
Ticker: (NYSE:QUAD)
Coupon: 7.000%
Ratings: B2 / B
Maturity: 05/01/2022
Pays: Semi-Annually
Price: ~101.0
Yield to Maturity: ~6.6%


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Disclosure: Durig Capital and certain clients may hold positions in QUAD’s May 2022 bonds.

Disclaimer: Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. The high yield strategies presented in this review by Durig Capital may not be suitable for all investors. This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.


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