This report was originally published 7/31/09.

We continue to recommend purchase of ARP shares, even after the 50% gain in the stock since we first introduced the idea.  The company will report results on August 6th, after the market close. We have received a few questions from investors about the potential for a revenue or earnings short fall from ARP given the recent decline in the AIA Billings Index.  We view the AIA Billings Index as an important barometer of revenue prospects for ARP, but it is not the only indicator we rely on.  Our checks with a few leading reprographers suggest that business trends did not improve dramatically in the second quarter, but they also did not get worse (stop us if you’ve heard that one before).  As a result, we think ARP is well positioned to post another quarter of earnings upside and strong free cash flow generation.

The Overall AIA Billings Index Weakened Over the Course of the Quarter, but New Project Inquiries Remained Strong

We have written about the importance of the AIA Billings Index in the past.  It is one of the best leading indicators of non-residential construction activity, which is a critical driver of revenues for ARP.  Some investors were spooked by the sizeable sequential decline in the overall billings index from May to June.  After three consecutive months in the 42-43 range, the index declined to 37.7 in June.  However, the New Projects Inquiries index remained above 50 for the fourth consecutive month.  Overall, we do not want to read too much into one month of data.  It appears that most architecture firms continued to see softness in project work over the course of the quarter.  Any reading below 50 implies a sequential decline in activity, so based on the AIA Billings Index alone one could not say that non-residential construction activity has stabilized.  It will be interesting to see if the uptick in New Project Inquiries over the past four months will result in a upturn in the overall billings index by the end of the third quarter.

Source: AIA

Despite Continued Weakness in the AIA Billings Index, Our Conversations with Leading Reprographers Suggest Business Has Stabilized

Over the past few weeks we have had the opportunity to get feedback from a few of the largest reprographics firms in the country.  Overall, the feedback we received suggests that revenues stabilized over the course of the quarter, but did not improve materially.  Interestingly enough, the reprographers increasingly think that the second half will be considerably stronger than the first half.  The overall number of projects has declined, but that has been somewhat offset by an increase in the number of general contractors bidding on each project which results in more documents printed per project.  You can read more about that dynamic here.

ARP exited the first quarter in the month of March with approximately $50 million in monthly revenues and gross margins approaching 40%.  It is also important to note the impact of seasonality on ARP’s business.  Over the past decade the company has NEVER witnessed a sequential decline in revenues from the first quarter to the second quarter.  There are many regions in the country where the construction cycle remains dependent on the spring thaw, as a result activity typically picks up in the second quarter.  Current consensus implies a 4% sequential decline in revenues from 1Q09 to 2Q09.  Based on our conversations with reprographers and typical seasonality, we expect the company to beat current consensus estimates for revenues and EPS of $133.6 million and $0.14 by as much as $10-15 million and $0.04-$0.06.  Perhaps most importantly, we anticipate the company will generate $15 million in free cash flow in the quarter and reduce its total debt outstanding to $270 million.  Based on our estimates, total leverage as measured by total debt/LTM EBITDA would be 2.5x, which we expect to be a peak for ARP over the next 18-months.

Taking a Look at ARP’s Next Growth Vehicle – ishipdocs and a Move Into the Non-AEC Space

American Reprographics Company announced the launch of ishipdocs.com at the 2009 IRgA conference. We view ishipdocs as the next step forward in ARP’s strategy to effectively capture maximum revenues in the transition from “print and distribute” to “distribute and print”.  Ishipdocs is a web-based platform through which reprographic firms can fulfill job orders all over  the world.  Historically, the reprographics industry has been almost entirely local. Architecture, engineering and construction firms submitted orders, which were printed and then physically distributed by courrier or other form of transportation.  Facilities management, whereby a client prints documents at its own offices and the reprographics firm manages the equipment and other service needs, was the first major step towards the “distribute and print” model.  Ishipdocs takes local fulfillment on a global scale.  Realistically speaking, ARP is the only reprographics firm which can fulfill orders on a national basis. However, management at ARP has always recognized that they should be able to fulfill the needs of their clients on a global scale.  Through ishipdocs this is now possible.

Firms signing up for ishipdocs will be able to bid on projects that have international document production requirements. International reprograhpers signing up on the ishipdocs platform will be able to receive jobs from the US.  Both sides benefit.  Additionally, clients are able to source print jobs that would normally take 4-6 days in 24-48 hours.  Overall, this results in a greater amount of reprographics activity that stays within the industry.  As the clear industry leader, ARP would be the biggest beneficiary of a growing reprograhics revenue pie.  Thus far, there are a few hundred reprographics firms that have signed up on the platform.  ARP receives a modest subscription fee from firms that have signed up, but the bigger benefit is the overall increase in printing jobs that are kept within the reprographics network.

In addition to expanding reprographics fulfillment on a global scale, we view ishipdocs as another platform through which ARP can gain further traction with non-AEC (architecture, engineering and construction) clients.  The company currently generates approximately 20% of its revenue from non-AEC clients, but there is no real reason we can identify as to why the company cannot leverage its existing equipment infrastructure and win more non-construction related business.  We expect the combination of international fulfillment and expansion into the non-AEC market to become a meaningful driver of revenue growth for ARP over the next few  years.  From a competitive perspective, we think ishipdocs has the potential to significantly damage revenue prospects for Fedex/Kinko’s and Innerworkings.  In the case of Fedex/Kinko’s, ishipdocs will reduce the number of jobs received at Kinko’s and also lessen the amount of prints that are shipped overnight.  In the context of Innerworkings, the company created an online bid platform for print jobs supported by a network of printers across the country.  It appears that ishipdocs is a direct competitor in many respects.  Stay tuned…

ARP Still is a Cash Cow, Please Act Accordingly

We were initially attracted to ARP shares due to the company’s strong free cash flow generation, dominant market position and astute management team.  We expect the company’s second quarter results to add further credence to our thesis.  As the table below demonstrates, the stock remains quite cheap based on our estimates.  We think the stock can trade as high as $15/share based on a 10% free cash flow yield.

Source: PAA Research

As always, please act accordingly….