Love-Hate Relationship With ADVO a Natural

ADVO (AD)

(Jim: Buy)

(Mike: Buy)

Jim: I find our stock today a very interesting story, Mike, because this a company that everyone constantly encounters and yet it’s not a familiar name.

Mike: Exactly. To put it another way, you’d be hard-pressed to find 10 people on the street who know what ADVO is and yet . . .

Jim: You’d be hard-pressed to find one person on the street who hasn’t had to look at ADVO’s products several days a week, in their mailbox.

Mike: Right. In fact, when you reach into your mailbox, and the check from your mother has vanished beneath the pile of junk mail and crappy coupons and handouts that is the rest of your mail, the company you have to blame is ADVO.

Jim: Get this: ADVO is the single largest customer of the U.S. Postal Service.

Mike: ADVO and its ilk call this direct marketing, you know, in the same way that the mobile-home industry says it’s in manufactured housing, or the junk-bond industry says it’s in the business of high-yield financing. They can call it direct mail but we know and love it as junk mail.

Jim: And ADVO, which has been around more than 70 years, is the king of junk mail. Based in Windsor, Conn., the company now has annual revenue exceeding $1 billion.

Mike: Now we’ve said before we often like a company and hate its stock, but this is a case where you might not like this company for clogging up your mailbox, but I like this stock and I’d buy it.

Jim: Me, too, even though we must point out a couple of disquieting things about this company.

Mike: I’m way ahead of you. For starters, ADVO is extremely overleveraged.

Jim: Right, it’s got so much debt that the company has a negative net worth! I thought only cable-TV companies engaged in that kind of behavior.

Mike: For all of our non-accountants out there, a negative net worth means that if you liquidated ADVO tomorrow its mountain of debt would completely outweigh its assets.

Jim: And that makes it a tad dicey to be a shareholder, because if matters ever got so bad that ADVO did liquidate, the bondholders would get nearly everything and the stockholders’ investment would be worth, well, about the same as junk mail.

But let’s be clear: ADVO is in otherwise good financial shape. By keeping business operating expenses under control the company has managed to boost earnings despite its interest bill.

Mike: There’s another matter that’s worth noting. Just since October, the price of ADVO’s stock has more than doubled because more and more investors are flocking to ADVO’s story. But this can be dangerous because it begs the question, How much longer can this stock keep gaining altitude?

Jim: True, but you could have said the same thing years ago about, say, Home Depot or Cisco Systems and missed some heady capital gains.

Mike: Yep, and let me point out that ADVO, despite doubling in price, is still selling for only 17 times its expected per-share profit for its fiscal year ending in September. That’s cheap and still leaves lots of room for the stock to keep climbing.

Jim: Plus, your mailbox is testament to the fact that demand from merchandisers for direct-mail advertising just keeps soaring.

Mike: The proof in the pudding also is that, in late-May, ADVO again announced that its quarterly revenue rose much more than Wall Street had expected, and that it was “cautiously optimistic” that its profit would also exceed estimates. I mean, this company just keeps generating strong numbers despite its debt load.

Jim: That’s not all. Debt or no debt, ADVO’s profit margin also keeps expanding. Five years ago the company barely earned two cents per dollar of revenue. Today it’s earning well over four cents. And I see its earnings and revenue continuing to grow, if not in double digits, at least in the high single digits for the next year or two.

Mike: You also have to like ADVO’s chief executive, one Gary Mulloy, who looks at this business with absolute serenity. The fact that interest rates are going up--which makes debt more costly--doesn’t faze him. ADVO’s balance sheet doesn’t faze him. In fact, he likes using debt to buy back stock on the open market--another plus for investors, as long as the debt stays manageable.

Jim: Why shouldn’t he be serene? Every week ADVO gets about 500 million pieces of advertising from its paying customers, which it then sends out to 60 million households. That’s cause for serenity. Demand for this kind of marketing obviously is robust.

Mike: And to Mulloy’s credit, he has thinned ADVO’s customer base from about 5,000 to 4,000, to keep just their most profitable accounts. So that has helped keep those profit margins growing.

Jim: Right. Frankly, this is a simple decision for me. Any company that can annoy so many millions of people because it’s flooding their mailboxes with paid advertising has got to be a good investment.

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Write or e-mail with a stock you would like to see discussed in this column. Peltz ([email protected]) covers the markets and corporate financial trends. Hiltzik ([email protected]) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). Either can also be reached at Business Section, 202 W. 1st St., Los Angeles, CA 90012.

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