Southern Graphics Group

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Southern Graphics Group, now known as SGK, is a provider of brand development services, primarily focusing on packaging design and production for large consumer packaged goods companies.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

SGK operates within the brand development and packaging industry, offering a range of services that include artwork and design, pre-press production, digital asset management, and marketing strategy for the consumer packaged goods (CPG) industry. It helps clients in the creation of product packaging that attracts the customer and translates well in manufacturing processes.

  • Revenue Distribution: SGK derives its revenue from a global portfolio of clients. Its services range from creating the artwork and designs, to preparing them to print. Its revenue is distributed geographically, with a large presence in North America and significant operations in Europe, Latin America, and Asia. They generally work with large, multinational companies. The breakdown is largely:
    • Brand Activation: services and technology solutions designed to optimize design and marketing performance. It generates the most significant amount of revenue, with revenue coming from fees for design and development of new packaging and marketing materials.
    • Creative Production: Pre-press production and prep-work related to the printing process. It’s a smaller portion of revenue.
  • Industry Trends: The packaging industry is driven by the continuous need for product differentiation, especially within a competitive CPG market. There’s been increased emphasis on digital transformation, which makes digital asset management and workflow solutions more and more important. The industry is moving toward sustainability, with increased demand for environmentally friendly packaging solutions.
  • Competitive Landscape: The CPG packaging space includes large design firms, smaller independent agencies, and large printing companies that offer pre-press services. Competition is quite high, with multiple players vying for contracts with CPG companies. Many competitors can offer a similar set of services and that is a major problem for SGK. They must constantly innovate to remain ahead.
  • What Makes SGK Different: SGK differentiates itself by being among the largest dedicated providers to CPG companies. It has established a reputation for combining its core services with innovative technology and strategy. SGK also works to integrate its software to create ease of doing business for its clients. The most important part is that they offer both artwork and prepress production, which is a relatively unique offering and their largest differentiator.
  • Margins: According to their recent reports, their gross profit margin is around 30%, which is normal for the business. Their EBITDA margin tends to be around 10%-12%.
  • Recent Problems / Controversies:
    • SGK recently went through an extensive strategic review of its portfolio of businesses that resulted in the divestiture of some assets and consolidation of others. This restructuring may take time to show its benefits.
    • The company has also been faced with increased macroeconomic pressures due to COVID, inflation and global downturns. This can affect revenue and client spending in the short term.
    • The company has been very focused on acquisitions to fuel growth. However, such activity often comes with integration difficulties and costs.

Financials in Depth

Let’s break down SGK’s financial health.

  • Profitability:
    • SGK has shown fluctuating revenue, but the company has maintained consistent and stable gross margins of 30%+. This means they have some control over their pricing.
    • Operating profit and EBITDA margins are more volatile, because of high R&D costs, and acquisition-related costs.
    • In the latest quarter, the company achieved a revenue growth of 6% year-over-year and the management has emphasized the importance of organic growth. This is a crucial metric because it shows their ability to expand within their core business instead of only relying on acquisitions.
  • Cash Flow:
    • SGK generates solid operating cash flow, which funds a good portion of its operations. However, it’s usually lower than their earnings because of the high amounts of noncash expenses and working capital changes.
    • Capital expenditure is also higher than it would be for most companies, because of the extensive development of software tools and implementation costs. The company expects to lower this spend in the next year.
    • The company has also used quite a lot of cash in acquisitions over the years, which can create complications and distract management.
  • Balance Sheet:
    • SGK’s balance sheet shows a fair level of debt, but nothing overly concerning.
    • Goodwill from previous acquisitions constitutes a large part of their assets. Since it’s intangible, that may be something to keep an eye on.
    • The company has managed to pay off most of their debts, but it has continued to take on debt for expansion purposes.

Moat Assessment

Moat Rating: 2 / 5

SGK’s moat is narrow, not particularly strong, but present.

  • Intangible Assets (Brands, Patents, Regulatory Licenses):
    • SGK has some intangible assets with their various proprietary software products and brand recognition among CPG customers, but they are not very strong or unique.
  • Switching Costs:
    • While switching costs can occur, due to the complexity of integrating new vendors, they are not that high. CPG companies can switch to other service providers for different products or needs, meaning there is a good chance that a competitor can gain a customer. It’s important to note that the switching costs are higher for pre-press production vs. design only.
  • Network Effects:
    • There are virtually no network effects at play for SGK.
  • Cost Advantages:
    • SGK has scale benefits from its size, but competitors can also scale up easily, meaning there is not a clear and durable cost advantage.
  • Moat Durability:
    • The company has not been very consistent in generating solid returns on capital (ROIC), which is a sign of no significant and clear competitive advantage, which means that their moat is not very durable.
  • Their reliance on technology can expose them to new disruptions from competition.

Risks to Moat and Business Resilience

  • Technological disruption: Changing technologies may affect their core service, making them less relevant.
  • Loss of customer concentration: If any of their major clients changes providers, it could result in huge losses for SGK. * Consolidation in CPG: As the CPG industry becomes more consolidated, these large customers may have more leverage with their partners.
  • Economic volatility: Macroeconomic conditions can impact SGK’s client spending.
  • Increased competition: Their offerings may be easily copied by others, especially with the technology becoming more democratized in recent years.

Understandability Rating

Understandability: 2 / 5 SGK is a moderately complex business to understand because it combines tangible processes with software design and integration that makes it a unique business compared to other businesses. You need to understand how the packaging business works to understand SGK, especially the printing preparation part of it. The software implementation makes the business even more complicated for an average investor.

Balance Sheet Health Rating

Balance Sheet Health: 4 / 5 SGK’s balance sheet is reasonably strong, with a manageable level of debt, substantial goodwill, and manageable cash levels. But debt levels must be observed going forward. The business generates enough cash flow and is reasonably healthy.