This report was originally published 7/30/09.

In our original post on the Brink’s Company, we argued that the company would perform well in the current economic environment based on the steady secular growth of cash in circulation (cash is still king), expansion of the number of ATM’s in place on a global basis, and continued expansion of retail banking locations. Brink’s has a steady business model that has a proven track-record of generating organic revenue growth and solid free cash flow in almost every economic environment.  Additionally, the company benefits immensely from dollar weakness, a quality which we think will come back into vogue in the next few quarters.

BCO reported 2Q09 results this morning, that fell short of street expectations.  You can read all of the details here.  Revenues were more or less inline with expectations, but EPS of $0.34 fell short of consensus of $0.40.  The company also lowered its full year outlook for organic revenue growth from mid-to high single digits to low-to-mid single digits and reduced its segment operating margin expectations from 8.0% plus to 7.0-7.5%.  The lionshare of the earnings shortfall had to do with operating weakness in three countries in Europe and currency conversion losses in Venezuela.  Operating margins for the company’s international operations declined from 7.7% in the first quarter to 2.9% in the second quarter.

The stock is weak today and we think current levels represent an excellent entry point for a stock where operating momentum is poised to improve.  Here are some of the factors that contribute to our confidence:

Improved performance in North America. While North America only represents 21% of BCO’s revenues, operations there were a significant drag on profitability in 2008. It appears the company has stabilized margins, despite overall lower transaction volumes and weakness in the jewelry channel. We think operating margins could return to 7.0% plus in the second half of 2010.

• Compusafe continues to gain traction. Compusafe, which is BCO’s proprietary closed loop cash management for point of sale locations has gained significant traction with retailers thus far. At the end of 2008, the installed base of Compusafe was 7,800 units. Thus far the company has added over 2,000 units to the installed based in the first half of 2009 alone. BCO management has targeted 11,000 units to be installed by year end. Compusafe offers clients counterfeit detection, integration of back-office systems and same-day credit for cash balances on customers’ premises. The product dramatically improves working capital turns, which should resonate well with retailers in this economic environment. For BCO, Compusafe improves traction with customers and is a higher margin business overall. Further penetration of Compusafe should push North American operating margins higher.
• Diamond/jewelry shipments are likely to improve substantially in the second half of 2009 following inventory destocking at retail in the first half. Historically, BCO has generated a significant portion of its revenues from the secure transportation of diamonds and other valuables. That service was a significant drag on profitability in the first half due to the sharp fall-off in demand for high-priced, luxury items. Retailers have been reluctant to carry excess inventory and have focused on reducing what they have in stock. There are signs that destocking has ended and retailers are restocking. The CEO of DeBeers Group, Gareth Penny recently indicated that the company expects to witness a sizeable sequential improvement in the shipment of rough diamonds in the second half of this year. This could result in a strong uptick in the velocity of jewelry shipments to retail, a direct benefit to BCO.
• Currency will go from a head wind to a tailwind in the second half. As we mentioned earlier, BCO generates approximately 80% of its revenues outside of North America. The company has sizeable exposure to the Euro, Brazilian Real, and Venezuelan Bolivar. YTD, currency has reduced revenues and operating income from the company’s international operations by approximately $150 million and $5 million, respectively. We expect currency to be a 6% drag on international revenues in the third quarter and become a 5% boost to BCO’s fourth quarter revenues assuming current exchange rates
• BCO’s decision to contribute $150 million to its U.S. pension fund reduces a significant overhang. In our original report on BCO, we thought the company would be able to manage contribution requirements of its underfunded pension over the next several years through strong free cash flow generation. Based on our estimates, BCO was capable of contributing $40 million annually to its U.S. pension and would still be able to generate more than $100 million in free cash flow. Management has elected to contribute $150 million to its pension fund in the third quarter in order to take advantage of a significant tax-break. The company will finance the payment with approximately $60 million in debt, $60 million in equity and $30 million from a tax refund. While some might view this as a negative, we think resolution of the pension overhang on BCO shares is a significant positive. The underfunded status will go from approximately (-$300MM) to (-$100MM) pro forma for the contribution. Additionally, from an accounting perspective the contributions will be accretive to earnings for the next several years. Management has indicated that the contribution will be $0.02 accretive to earnings in 2009 and $0.04 in 2010. Our accretion/dilution analysis suggests accretion could be higher. The table below outlines the impact that the $150 million pension contribution could have on BCO’s earnings and cash flow over the next five years:

Source: PAA Research

• BCO’s valuation still looks compelling. Despite the earnings shortfall in 2Q09, we don’t expect street estimates to change materially following results. BCO has consistently generated returns on capital and equity in excess of 20% and yet the stock still trades at 12x our revised 2010 EPS. We still see upside to $33-$37 by year end based on a 16-18x multiple of our 2010 EPS estimate of $2.28. We think the stock is more likely to see multiple expansion now that the pension overhang has been resolved. The table below highlights are estimates for 2009 and 2010 and the valuation of BCO shares.

Source: Yahoo Finance, PAA Research

As always, please act accordingly…

Disclaimer: The author of this post owns calls in BCO, positions can change at any time without notice.