We introduced BCO as a long idea approximately 9-months ago, you can read our original report here.  It has not been our best call. The stock has effectively gone no where while equity markets have ripped.  On Thursday, 4/29 BCO will report 1Q10 operating results.  We anticipate the company’s earnings results could represent a positive inflection point for BCO and should finally lay to rest 2009’s “death by 1000 cuts”.  Just to review, here are all of the issues that BCO faced in 2009:

• A deeply underfunded pension following the 2008 market collapse, which caused the company to contribute $150 million to its U.S. pension plans during 3Q09.
• Political instability in Venezuela which led management to the decision to repatriate cash from its Venezuelan subsidiary at 5.92 bolivar/dollar (in the fourth quarter) compared to what used to be the stated exchange rate of 2.15 bolivar/dollar.
• An incredibly weak demand environment for diamonds and other precious jewelry, which severely hampered financial results for the company’s higher margin value added services
• Competitve pressures in Europe, the company’s single largest operating segment, which hurt organic growth and operating margins over the course of the year

Of the issues that plagued the company in 2009, only the competitive pressures in Europe will have a meaningful impact on BCO in 2010.  We think BCO started to generate meaningful operating momentum in the first quarter, which should help the company produce revenue growth and free cash flow levels inline with historical averages.  Over the next 12-18 months we think BCO’s revenue free cash flow, and earnings growth should be augmented by the following factors:

Expansion of the Installed Base of Compusafe.

Compusafe, BCO’s proprietary closed loop system to help retailers reduce theft, improve working capital turns, and manage cash has achieved rapid acceptance.  In 2009, Compusafe’s installed based increased by 37% over 2008 levels.  There are now more than 10,000 retailers using Compusafe at the point of sale.  BCO management expects the installed base of Compusafe to increase by as much as 30-40% in 2010.  Sales from Compusafe accounted for 7% of BCO’s total North American revenues and 2% of the company’s total in 2009.  Although Compusafe is not a huge contributor to BCO’s topline at this stage, it has achieved enough critical mass that it can boost the company’s total revenue growth by 50-100 bps annualy for the next 3-4 years in our opinion.  Additionally, Compusafe is a higher margin revenue stream than the company’s traditional cash in transit services.

A Recovery in the Diamond Trade

BCO generates approximately 30-35% of its revenues from “value-added services”, which include everything from Compusafe to the transportation of valuables such as jewelery.  Revenues for this service line have historically been dependent on the velocity of the jewelry trade and pace of sales in other high priced items.  From the second half of 2008 to the end of 2009 an unprecedented decline in jewelry sales reduced demand for BCO’s value added transportation services.  However, in the first quarter it appears that the diamond trade started to rebound.  We have analyzed import and export data from the Rappaport Group in three major diamond markets: the US, India, and Israel.  In each country import/export volume increased in excess of 50% in the first quarter on a YOY basis.  The charts below depict the diamond trade volume in the US, India, and Israel over the past two years.  In the US, polished diamond imports (the US does not export many diamonds) increased 60% YOY in the first quarter, but were still down 15-20% compared to 1Q08 levels.

India has become one of the largest polished diamond exporters in the world over the past decade.  Polished diamond exports increased approximately 90% YOY in 1Q10 and are now above 2008 levels.

Israel is a smaller diamond market than the US and India, but is one of the world’s largest.  Total diamond exports increased over 80% YOY in the first quarter.

Rapid Growth In BRIC Countries

The relative penetration of cash in transit and cash logistic services is much lower in emerging markets in Latin America and Asia.  We expect demand for BCO’s services in these markets to increase at a CAGR of 15-20% over the next 3-5 years.  ATM penetration in these markets is relatively low and cash in circulation trends are favorable.  As the chart below demonstrates, the number of ATM’s per capita in Brazil and China is half that and one-fifteenth that of that in the US, respectively.

Over the past 12-15 months, BCO’s primary use of capital (outside of the pension fund contribution) has been to expand its presence in BRIC countries.  The company now has critical mass in Brazil, Russia, India and to a lesser extent China.  In 2009, BCO generated 25% of its total revenues in Latin American and Asia.  In 2010, we expect the revenue contribution from these emerging markets to be closer to 30%.

PAA Research Estimates vs. Consensus

We currently forecast 1Q10 revenues and EPS of $737 million and $0.36 compared to consensus of $721 million and $0.32.  We expect currencies to provide a solid revenue tailwind for the company for 1Q10.  Our revenue estimate includes a 5% topline benefit for the company’s international division from currency and 1% for North America.  The company’s operating results will be negatively impacted by further weakness in the Venezuelan Bolivar, although BCO’s operations in that country only account for 5%  of total revenues pro forma for the shift to the “parallel rate” so the company should be less impacted by currency swings going forward.  In general, after a choppy year in 2009, we think a relatively “low bar” for consensus estimates has been set.  The company’s guidance of low-to-mid single digit topline growth and 7.0-7.5% divisional level operating margins could prove to be conservative given the recovery in the diamond trade, growth in Compusafe, and nascent global economic recovery.

Operating Momentum, High ROIC, Strong FCF Generation Should Lead to Further Stock Price Gains

BCO shares have increased 15.1% YTD compared to a 6.4% gain for the S&P 500.  It appears that investors have started to discount some level of mean reversion in the company’s secular growth rate and how the company will benefit from a broader economic recovery. However, we think shares are remarkably cheap given the company’s high returns on invested capital, strong free cash flow generation, and growing operating momentum. BCO still has a powerful secular growth story as it continues to benefit from the global increase in cash in circulation and an increase in the installed base of ATM’s.  We think shares can trade into the mid to high 30-’s over the next 6-9 months based on a 17-18x multiple on our FY11 EPS estimate of $2.03.

As always, please act accordingly…