November 21, 2007

American Repographics

The stock I'm highlighting today is so seriously undervalued, I've staked part of my professional reputation (and some cold, hard cash) on it. You see, I recommended American Reprographics (NYSE: ARP) in the November issue of Inside Value, our value investing newsletter. Since no good deed goes unpunished, the firm promptly missed its third-quarter earnings. Shares have tumbled roughly 30% since I recommended it -- but I'm not concerned.

At approximately eight times the size of its nearest competitor, American Reprographics is far and away the dominant firm in the fragmented reprographics industry, reproducing graphics for the architectural, engineering, and construction (AEC) markets. But printing all the documents relating to a construction project is only the first rung on the "value ladder." American Reprographics also provides document management, thanks to a proprietary platform that it licenses to other firms as the industry shifts from analog to digital technology.

The company is determined to press its competitive lead through an aggressive acquisitions program, having already purchased more than 100 smaller reprographers since 1997. American Reprographics now has more than 280 branches in North America; none of its competitors can boast a national footprint.

You say residential, I say commercial
American Reprographics' stock has been pummeled lately, losing more than 50% year to date. This owes partly to investor concerns about the effects of the housing crisis on American Reprographics' franchise. However, it's worth remembering that less than 15% of the firm's revenue is tied to residential construction, with the majority (65%) derived from commercial construction projects. During the third quarter, the company did register a slowdown in the former segment, but the latter remained healthy. Furthermore, the housing downturn is reducing the valuations of smaller rivals, making them more attractive targets for American Reprographics.

The ultimate margin of safety
In a recent interview, First Eagle Funds' star value manager, Jean-Marie Eveillard, noted that the distinction between Benjamin Graham's and Warren Buffett's approach to value lies in their approach to a stock's "margin of safety." Graham defined the margin of safety as the amount by which a stock's intrinsic value exceeded its market price; he would entertain buying any stock where a margin of safety existed. However, Buffett learned that it may be worth paying full value for outstanding businesses, because of their ability to compound shareholder wealth. Steady increases in intrinsic value create their own "margin of safety" by reducing the odds of a permanent loss of capital.

My point? American Reprographics is the best sort of undervalued stock, offering both forms of "margin of safety." Its present intrinsic value is higher than the price at which shares are currently changing hands, and I fully expect that intrinsic value to increase over time, thanks to a disciplined acquisition program and profitable organic growth. American Reprographics' depressed share price is no blue-light special -- it's a clear invitation to buy quality on the cheap this Black Friday.

Still not convinced? Don't overlook the firm's growth opportunities in China, and in catering to other industries. (The firm recently signed a three-year contract with Boeing, potentially worth $45 million.) In addition, management is aligned with outside shareholders through an aggregate 19% ownership stake in the company.

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