Introduction

Countless items get shipped around the world every day. With the rise of eCommerce, this isn’t bound to stop anytime soon. And while the obvious choices for investors to profit from this trend have been the Amazon’s or the Shopify’s, there’s one Canadian microcap that I think may turn out to be a sneaky compounder amidst it all.

Enter SupremeX (Ticker: SXP), the boring-est business you’ve never heard of and one of North America’s leading providers of envelopes, custom labels, and eCommerce packaging. This business is a true Peter Lynch special – Lynch loved growers in stagnant and unloved, unexciting industries, and SupremeX’s envelope segment fits this bill perfectly – but with a pivot towards manufacturing packaging for pharma, beauty, and eCommerce products scheduled for 2025, this story may have a more enticing future ahead of it, too.

*Disclaimer: I am not a financial advisor, planner, analyst, or any other certification related to finance. This article, and everything else from Hourglass Investing, is intended for research and entertainment purposes only. Please don’t make any investment decisions based solely on what you read.*

**Disclaimer: I do not own shares in SupremeX**

SupremeX

As of Writing:

• Market Cap: ~$113m

• Gross Margins: 32.5%

• 5-yr ROIC: 25%

• P/E: 4.37x

• EV/S: 0.7x

• Revenues: $307m (+24% YoY)

Note: As SupremeX is a Canadian co., all dollar values will be in $CAD, unless otherwise stated.

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The Company

SupremeX was founded back in 1977 as Enveloppe Supreme, and life continued on as normally as it would for any humble envelope company, making the occasional splash and acquiring other Canadian envelope businesses but otherwise plugging along. They were acquired briefly in 1995 before being sold off again just a decade later.

A year after that, SupremeX went public, undergoing an IPO on the Toronto Stock Exchange with an equity raise of $165m. The business pulled in $196m in annual revs that same year. The money raised in the IPO went on to fund several years of acquisition, but after nearly a decade of middling results, slow to little growth, and an approximately 75% decline in the share price, it was time for a change.

Stewart Emerson was appointed CEO in 2014 and immediately set to work implementing an ambitious strategic plan – to take advantage of a secular decline in the envelope industry and a fragmented competitive landscape to dominate the market. Meanwhile, he would siphon the cash generated from the envelope business towards funding a pivot into packaging – a move he hoped would keep SupremeX relevant and growing for years to come.

While overall returns since the company’s 2006 IPO at $10/share have been about -58% – hardly anything to write home about – things have improved since Emerson’s takeover and strategic pivot. Since his promotion in 2014, shares have grown at a ~5% CAGR and have returned an incredible 46% CAGR since the stock got pummelled by the onset of COVID a little more than three years ago.

Under Emerson, the company has consistently seen incoming trends and moved to stay ahead of them – not only through their shift towards packaging, which came prior to the major boom in eCommerce, but also through recognizing and capitalizing on a growing trend towards sustainability. The company now caters to environmentally conscious customers in need of low-impact, biodegradable packaging as a major part of their value proposition.

Today, SupremeX has more than 1000 employees across 17 North American facilities and is among the leaders in the wider North American envelope industry, with a growing diversification into folding carton and eCommerce packaging products that will be crucial to SupremeX’s long-term success, and perhaps in their ability to deliver returns to shareholders too.

Company Grade: A-

The Business

Business Model

SupremeX’s business model is very much a tale of two cities – or segments, I should say. While their business model has historically been centered around the envelope industry, the future of their business is reliant on their newer packaging and labels segments.

However, both are simple and easy to understand – always a bonus for investors. SupremeX operates 17 manufacturing facilities across North America, mostly centered in the eastern regions of Canada and the U.S., as well as two distribution centres. Manufacturing facilities produce either envelopes or packaging, with only two manufacturing plants providing both.

Within each segment there are a number of specific offerings, as well as differing strategies and emphases from management, so let’s dive into the specific segments.

Segments

Envelopes

Envelopes have always been SupremeX’s bread and butter; with a #1 position in Canada and the #2 spot for the total North American envelope market, they manufacture stock and custom envelopes across a wide range of sizes, colours, and paper qualities for their customers across the continent. Customers range from commercial and office supply companies to direct end-use corporations for custom envelopes. SupremeX also offers adjacent services like graphic art printing and warehousing & distribution for customers that do not want to manage inventory.

The envelope industry as a whole may be on the decline, but the company has no plans to wind down this segment as they diversify into packaging. Contributing about 70% of SupremeX’s total revenues on an annual basis with an 8.3% CAGR since 2017, they plan to use the stable cash flows from their envelope operations in Canada (where they have 85% market share) towards making even more envelope acquisitions in the more fragmented U.S. envelope market. They’ve demonstrated this strategy with the acquisitions of envelope companies Niagara Envelope in New York and Royal Envelope Corp. in Illinois.

Continuing to expand into an industry in secular decline may seem like a strange move, but this is a strategic move on SupremeX’s part – the company isn’t very likely to face much competition in a dying industry, and the U.S. envelope market is still fragmented enough that SupremeX can leverage its expertise and leadership to continue picking up smaller businesses. This will allow SupremeX to play the role of a consolidator that may eventually be able to dominate the envelope market and have pricing power with their customers. And despite the broader declines in envelopes, there is still demand and a strong customer base, evidenced by the moderate growth this segment has continued to deliver over the last 5 years.

While they’ve targeted the pivot towards packaging to diversify their product mix, SupremeX will also continue to focus on growing their envelope segment in the United States to become a dominant North American player in this low-competition market. The fragmented market in the U.S. provides some further growth opportunity for this segment, while the stable cash flows and steady, dependable revenue contribution from existing envelope operations will continue to help fund future acquisitions in both the envelope and packaging segments.

Packaging & Specialty Products

Normally, a company driving 70% of its total revenues from an industry in a slow and drawn-out decline would concern me as a long-term investor – but that’s where SupremeX’s packaging segment comes in. Packaging gives them a diversified product offering in a growing market that offers them downside protection as the envelope segment continues to decline. Much of their growth in this segment has come through acquisition, with 5 businesses purchased over the last 5 years in both Canada & the United States, and plans to further expand through acquisitions.

Within the packaging segment, SupremeX offers three primary products:

• eCommerce packaging & labelling

  • Customized products shipped directly to brand or plain packaging to distributing companies, plus accompanying labels.

• Folding carton packaging

  • Paperboard that is cut, folded, and glued for customers, with a high level of customization available to customers.

• Specialty products

  • All the fine accessories that go with shipped goods – specialized labels, polyethylene bags, bubble wrap, paper inserts or booklets, even record sleeves (this is an offering they really pump, for some reason)

While only 30% of total revenues come from packaging, this is the ‘enticing’ part of the business – if you can call a business focused on making boxes enticing, anyways. Since 2017 this segment has grown revenues at a 17.3% CAGR, nearly 10% higher than the envelope segment, with a whopping 35% YoY growth. Unfortunately, this segment is also lower margin than the envelope segment, largely due to more competition in the packaging space, which I’ll get into later on. Manufacturing businesses are often vulnerable to this commoditization of undifferentiated products, such as packaging, ultimately allowing very little in the way of pricing power and driving lower margins as a result.

Overall though, the pivot to packaging seems to be going well for SupremeX – considering the sustained growth in the segment and ramp-up in TTM revenues, it looks like the company is finding synergies between their envelope & packaging segments and tucking acquisitions in smoothly.

Acquisitions

Looking at this chart of all-time acquisitions by SupremeX, it’s pretty evident when the company’s new strategic plan came into place – after just 7 acquisitions from 1990-2010, SupremeX has made 11 acquisitions since 2015. Most of these have been U.S. envelope companies or packaging companies in either Canada or the United States.

Customers

Between the packaging and envelope segments, SupremeX caters to more than 6000 customers, including a number of big-name clients you’ll likely recognize: Costco, Xerox, Bath & Body Works, Telus, Rogers, Purolator, Gillete, Canada Goose, and most of the big Canadian banks.

As for the actual type of customers that SupremeX is targeting, and which makes up the majority of their customer base, that varies more between segments and individual products. With the envelope segment, they are mostly targeting large corporations that send out flyers or mail marketing, but also direct mailers, resellers & wholesalers, and office & commercial suppliers. The big banks are a perfect customer for this segment, hence why RBC, TD, and CIBC are all among SupremeX’s largest clients – every quarter these banks send out a boatload of financial information to all of their individual customers, and each of those come nicely bundled in a SupremeX envelope.

Within packaging, the customer base is more diverse. For folding carton packaging, SupremeX’s targeted customer base is companies selling products in pharma, cosmetics/fragrances, and nutritional supplement areas, as well as some food distribution, though this is limited to only a few geographies. Pharma in particular is a big one for SupremeX, as they obtained regulatory certification to provide pharma packaging, potentially giving them an extra niche that some other packagers may not be able to compete in without approval.

For eCommerce, customers include retailers entering eCommerce, businesses that need specialized packaging (weird sizing, shapes, extra protection, etc.) and environmentally conscious shippers. Their primary clients, though, are businesses providing subscription boxes – “new set of tiny hot sauce bottles every month” sort of thing – or companies that really focus on the “unpackaging” experience. SupremeX is able to cater to these kind of customers with the high degree of customization they make available to their customers, making them a provider of choice for businesses that focus on every last detail to make the unpackaging experience a part of their value proposition.

Expansion Strategies

SupremeX’s path to growing the business is superbly simple to understand – using the steady cash flows from the envelope segment to continue expanding the business, SupremeX will continue with the multi-pronged strategic plan they implemented in 2014 for maintaining their Canadian market position, consolidating the envelope market, and acquiring/growing the packaging segment.

Consolidation

The first part of SupremeX’s expansion strategy is to continue consolidating the envelope industry, with a focus on expanding their geographical reach. While the company will certainly seize on opportunities to acquire in Canada, these moves will simply be to maintain their leadership position in Canada, where the company already dominates 85% of the market.

Most of their consolidation efforts will instead be focused on the United States, particularly in the larger, higher-volume, and more attractive Northeastern and Midwestern U.S. envelope markets. As seen in the diagram below, the Midwestern and Western regions are almost completely untapped, potentially offering a large growth opportunity.

Grow the Packaging Segment

The second prong in SupremeX’s strategic plan relies on the first – from the envelope segment will come the steady cash flows necessary to continue expanding into the packaging segment, an actively growing industry that is a central long-term growth strategy for the company.

SupremeX has earmarked 2025 as the year that the packaging segment overtakes envelopes in total revenue contribution – assuming the envelope segment continues growing at a ~6% CAGR to 2025 for $260m in total revenues (a conservative estimate, considering their past growth and the potential of the U.S. market), then the packaging segment would need to grow at a 57% CAGR over the next 2.5 years just to equal the envelope segment.

While this may not be wholly impossible, it’s unlikely. Packaging driving 1/2 of total revs by 2028 seems more likely, but they may be able to hit this target sooner if they are able to hit a critical mass through their packaging acquisitions that would allow them to start scaling faster. Either way, the packaging segment is the real growth story for SupremeX and will be a key not only to their overall expansion strategy but also to an investment thesis in the company.

Business Grade: B+

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The Team

Oof.

I always start a team review with a quick look at Glassdoor, and I have to say, SupremeX’s rating is one of the worst I’ve ever seen. Now, granted, this is an industry which doesn’t necessarily attract a ton of career opportunities in general and is therefore more oriented towards low-salary workers, so it’s not very likely to receive raving reviews. Even still, a 52% approval rating on the company overall and just 41% on the CEO is pretty grim.

And for a consolidator like SupremeX, which is so reliant on acquiring other business, reputation is an important factor. Businesses have to want to be acquired by them, and seeing terrible employee ratings might scare away smaller envelope/packaging manufacturers that SupremeX wants to acquire but whose owners want to do right by their employees.

I’ve also rarely seen such divided opinions in reviews – I’m guessing this comes mostly down to which facilities employees were working at, but some complained about terrible management and a lack of innovation or investment in equipment, while others raved about a great and innovative management team focused on growth. Several reviews talked about great new leadership coming into the company. I also noticed that many of the lower-level employees (warehouse, machine operators, etc.) rated the company much worse than higher-level employees (sales, marketing, etc.).

Overall, not a great showing from Glassdoor, but take it with a grain of salt.

CEO

Stewart Emerson is a SupremeX lifer – after completing a double major in management and marketing, he initially started his career as an accounts manager at Innova Envelope in 1990 but joined SupremeX after they acquired Innova in 1991. He’s been with the company ever since, and for more than 30 years worked his way up the ladder through sales and management roles until he was promoted as President and Chief Exec in 2014, at which time he initiated the strategic plan to begin SupremeX’s turnaround.

Under Emerson, SupremeX has ramped up acquisitions, started the pivot into packaging, and focused on consolidating the envelope industry, while growing the company from an ~$80m market cap to today’s $114m mark.

Management Team

The rest of SupremeX’s management team, like Emerson, come from business backgrounds and have lots of experience in the envelope or packaging industries. Between Emerson, President Joe Baglione (Envelope Segment), President Simon Provencher (Packaging Segment), and VP Murray Rundle (Marketing & Innovation), the management team has a combined 110+ years of experience in the industry and 85+ combined years at SupremeX from Emerson, Baglione, and Rundle. Provencher is a newcomer, having come to SupremeX in 2022 to head up the packaging segment. He has previous experience as general manager of a folding carton business, where he was responsible for four business units across seven manufacturing plants. The only problem with lots of experience is lots of age… SupremeX’s management team is mostly 50+, which doesn’t inspire a lot of confidence in their long-term staying power with the company.

The CFO, Francois Bolduc, is the sole representative of the management team with no previous experience in the envelope or packaging industries specifically, but he is CPA-designated with more than 25 years of experience in finance. Now, it’s with the CFO that my main concern with SupremeX comes – Bolduc is fresh to the job, as of July 2023, and his sole experience with a publicly traded company was Bombardier, a company that has struggled to say the least. Bolduc was VP of Finance for the Aerospace Division, a segment which has been largely gutted now due to a series of events that took place during Bolduc’s time there.

To place the blame fully on Bolduc would be silly – there were larger factors at play in the demise of Bombardier’s aerospace segment, many of them geopolitical, and he would not have been solely responsible for many of the poor financial choices that were made before he got there (taking on huge debts), but it isn’t super encouraging regardless. As some relief to this concern, Bolduc is very highly spoken of from former employees, who cite his ability to lead teams effectively, focus on strategic initiatives, and drive change in organizations.

The main cause for concern, though, is less to do with Bolduc and more to do with SupremeX’s ability to burn through CFO’s. SupremeX hired Guy Provenost in 2018; just three years later, in 2021, he left SupremeX to be replaced by Mary Chronopoulos; now, only two years into her time at SupremeX, she has also resigned to be replaced by Francois Bolduc.

The CFO is a super important role in an organization and not one a business wants to be switching up often, which makes the fact that SupremeX has cycled through three different CFO’s in just 5 years a little alarming. Constantly replacing CFO’s creates transitory inefficiencies, disrupts continuity of financial strategies, and erodes investor/shareholder confidence in the management team, ultimately impacting the overall attraction of the investment.

CFO upheaval is my main knock against an otherwise very experienced management team – if Bolduc only stays a few years before leaving as well, I would consider this a very major red flag to management’s ability to get along with and retain a role that is crucial to the business’s long-term success.

Capital Allocation

SupremeX has a very defined list of capital allocation priorities:

1. Acquisitions

2. Capital expenditures

3. Dividends

4. Share buybacks

The acquisitions we’ve discussed – it’s a key part of their growth strategy and their #1 investment priority. Capital expenditures, obviously, help to keep the business afloat and efficient – things like investments in new equipment and energy-efficient lighting for their warehouses. Their capex spending seemed really strategic for operational efficiencies to me.

Now the dividend, I don’t love. It’s not my favourite way of returning cash to shareholders and, to my mind, there’s enough of a growth story here that pumping any free cash towards a dividend doesn’t make a ton of sense. However, now-former CFO Chronopoulos also commented on this during a recent earnings calls, saying that the dividend payment didn’t impact their ability to continue making acquisitions – supported by the only 12% payout ratio on the dividend.

I maintain that I don’t love it – and if it’s such a low payout, I’m not really sure what the point is. I’d prefer to see shareholder return in the form of more tax-efficient share buybacks. On that front, they have initiated some buybacks, mostly in 2020-2021 during COVID when the company cut the dividend and instead focused on buying back their shares, which were getting absolutely hammered. They initiated some more buybacks in the back half of 2022, and stated in August ‘23 that they’d be buying back another 5% of their total outstanding shares.

Overall, the capital allocation priorities get a good grade from me. Capital expenditures add a lot of operation efficiencies and management continues to prioritize growth – my only complaint is that I wish they’d cut the dividend altogether and focus exclusively on share buybacks. Especially with the stock trading at a nearly 23% FCF yield, I think there’s some great value to be found for the shares they are repurchasing. Their share repurchases have been done pretty strategically – usually at times when the shares have been hit hard, so hopefully that trend continues with this most recent round of buybacks.

Ownership

Unaffiliated investors own the vast majority of this stock at around 60%, while there’s lots of shareholder alignment with more than 36% of the company being owned by management or the board of directors. Best of all, there’s very little institutional ownership.

While this can be a little bit of a double-edged knife – sometimes there’s a good reason they don’t own it! – in this case it is likely only because SupremeX is too small a company to warrant much attention from institutions. This provides an opportunity for individual investors to find meaningful value and upside potential in an under-looked stock. And SupremeX insiders certainly seem to think there’s good value in the stock at the moment:

Very encouraging signs. Members of the board and management team have been eating up shares all the way down from $5/share, showing they have lots of confidence in the stock, are willing to align themselves even further with outside shareholders, and are seeing a lot of upside at current prices.

Team Grade: B+

The Industry

There are two industries that need to be looked at when talking about SupremeX: envelopes and packaging. And they are in two very different phases.

Like I’ve mentioned, the envelope segment is dying. To the surprise of absolutely no one, there’s been an overall decline in the amount of mail sent for both marketing and personal communication purposes. Digital ‘mail’ is faster, cheaper, and easier – and entire generations are growing up with know-how only of this modern method of communication.

Heck, I’ve never even sent a letter. I’d probably have to Google how to do it, if I were to. But I won’t. Because there’s no point. And I am not unique in this matter – it’s simply indicative of the wider market trend in envelopes. Bills are now sent and paid online, marketing is sent mostly by email, not physical mail. However, neither marketing nor personal mail is completely zilch – marketing mail, in particular, still has a relatively significant demand, even if it’s shrinking. Banks, retailers advertising deals, flyers, charities, etc.

Now packaging is a different story. Packaging is the growing industry, and is a central part to SupremeX’s strategy to remain relevant in the coming decades. With the rise in eCommerce, sped up partly by COVID and wider trends in digitization, the amount of goods that require packaging for shipment are on the rise. So SupremeX is catering to two different total addressable markets that are on completely opposite ends of the spectrum in terms of size, growth, and competitiveness.

TAM

Envelope

The total addressable market for envelopes is approximately $140m in Canada and is very concentrated amongst 5 players, of which SupremeX is the clear leader with players #2 and #3 combining for only $15m in revenues. The U.S. market, by contrast, is worth approximately $2bn but is incredibly fragmented, with SupremeX making up only 6-7% of the total market.

Despite being the second-largest provider of envelope manufacturing in North America, SupremeX’s $224m in TTM revenues accounts for only ~10.5% of the total market. This gives them plenty of opportunity to play the consolidator and start eating up smaller players in the envelope industry to dominate more of the market share.

Packaging

The packaging market makes envelopes look like a silly little endeavour – folding carton packaging alone is estimated to be worth nearly $150bn globally and growing at a 4.6% CAGR, which will see a market size of about $175bn by 2027. eCommerce packaging is smaller, worth ~$70bn but growing much faster, with an estimated 17% CAGR that would see it become a nearly $350bn market by 2032.

Both folding carton and eCommerce packaging markets are expected to grow as a result of tailwinds from digitization, home delivery, and online shopping trends, while the folding carton market should also benefit from a growing preference for paper-based & biodegradable packaging instead of plastic. SupremeX’s packaging segment stands to benefit from all these trends, but the company has also strategically emphasized the sustainable part of their business and cater towards environmentally conscious consumers in order to take advantage of this trend in particular.

I have spoken about this while analyzing other companies – think what you will about sustainability initiatives and the overall effectiveness of ESG, but companies that place themselves on the right side of this trend early are, to my mind, at an advantage over those competitors that lag on sustainability metrics/offerings. And unfortunately, a higher growth market means many more competitors, so every advantage counts. However, where the dying envelope industry doesn’t really have much room to share the wealth among many players, the future $350bn global market for packaging means there is likely room for a few players to succeed.

Competition

The Canadian competitive landscape for envelopes isn’t even really worth mentioning – the next-up players in the space are tiny compared to SupremeX and things would have to go terribly wrong for SupremeX to lose their advantage in this market. The U.S. market, on the other hand, is a different story – here, SupremeX faces competition from North America’s #1 envelope manufacturer, Cenveo, and Tension Envelope, another large regional player. There are countless smaller players as well, but these are mostly just acquisition fodder for the three big fellas.

Envelopes

Cenveo

While SupremeX grows and diversifies, Cenveo has taken a more belly-up approach to the envelope industry’s decline, first declaring Chapter 11 bankruptcy in 2011 and then shortly afterwards delisting from the Nasdaq. More recently they shut down one of their facilities in Indiana and laid off 127 workers with no explanation, though likely a result of a continued needs to cut costs.

Prior to delisting, they were pulling in ~$1.3bn from a combination of envelopes, labels, and coating services, so the company definitely had a significant presence in the envelope industry. Massive amounts of debt continued to weigh on the company though, and growth was not significant enough to mitigate the impact of interest payments on the bottom-line. As financials are now not disclosed as a private company, it’s hard to say how the company has done since delisting, though plant closures may be telling.

Tension Envelope

One of the lamentable parts of analyzing micro-caps is that their competitors are often private companies that make it very difficult to do side-by-side analysis or find information on the competitive landscape. Tension Envelope is just such an example.

Tension is very similar to SupremeX in that it continues to consolidate in the envelope industry while expanding into packaging for eCommerce & pharma. They seem to be about the same size too, with most sources I found saying they were expected to generate between $200-$300m in revenues this year. However, their operations are concentrated in the U.S., with some exposure in China and Taiwan as well, and they operate eight manufacturing facilities as opposed to SupremeX’s fifteen.

Packaging

With great growth comes great competition, as Peter Parker’s uncle said. Or something along those lines, anyways. The point is, there are a ton of players trying to take advantage of this huge space. While I’ve highlighted below a few of SupremeX’s competitors in the Canadian space, there are countless packaging companies in the United States that SupremeX will be competing with – too many to really get into. This is one of the risks with SupremeX’s diversification into packaging as well – its outside the box (haha) from what they’ve previously had experience with, and they face an enormous amount of competition in both Canada and the United States.

MAX Solutions

MAX Solutions is a newcomer to the game, having been founded in late 2021 to provide specialty packaging products. Like SupremeX, MAX Solutions offers folding carton, specialized/customized packaging, and labels for eCommerce solutions. However, MAX also offers rigid boxes (like the kind you might expect to get a fancy rum bottle in), trays (for fast food), and paper foam products, giving them a more diversified packaging portfolio overall. They also recently acquired The Ellis Group company to expand their packaging business into Canada, with three package manufacturing plants in Ontario being included in the deal.

While I couldn’t find any revenue figures or really much information at all on MAX, the company is headed up by two industry vets, who founded a previous packaging business and built it up to $2bn in revenues before selling it. They have pretty long histories in the packaging industry and will definitely serve as some strong competition to SupremeX, though they may fall behind SupremeX’s rate of acquisition without the funding of being a publicly traded company.

Ingersoll Paper

Where SupremeX is new to the game, Ingersoll is a veteran. With more than 100 years of experience in packaging, they’ve built up a list of assets and a level of expertise within the packaging industry that will not be easy for SupremeX to replicate. They focus primarily on folding carton packaging, but cater to a wide range of industries and use cases, including pharma, beauty, fragrance, cannabis, food/beverage, electronics, and other consumer discretionary items. Ingersoll, too, focuses on customizable packaging and on sustainability by catering to the environmentally conscious packaging consumer.

However, Ingersoll is a much smaller business than SupremeX – they operate only one manufacturing facility in Ontario, and I believe SupremeX’s rate of acquisition will quickly turn them into a larger player in the packaging space than Ingersoll Paper.

Vertically Integrated Giants

There are a few behemoths in the industry which I didn’t get into here because it’s difficult to get direct comps, but there are some massive and vertically integrated packaging companies that also control the recycling, pulp, and paper segments of their business in addition to the packaging. SupremeX definitely competes with them in the packaging space so I’d recommend looking into them if you’re interested in SupremeX, but since SupremeX only directly compares with a portion of these businesses, I didn’t analyze them too deeply.

International Paper, Westrock, Ball Corporation, and Crown Holdings are all ~$10bn examples of these vertically integrated packaging giants.

In Summary

Ironically, their operations in a dying industry are almost the more attractive part of SupremeX. Unlike the envelope segment, packaging is not an industry designated to a few key providers, and SupremeX will face a number of competitors. So while the packaging segment is the faster grower by far, they face so much competition in this space that the risks become much greater. As a consolidator, they may face bidding wars from other acquirers in the space that could make it difficult to acquire businesses at fair prices or may reward larger players with more cash to splash than SupremeX.

As for the operations already under their umbrella, they face the risks that every other manufacturer does – perhaps more so, given the relative lack of complexity involved with manufacturing paper/cardboard boxes. There’s simply not a huge barrier to entry, which often leads to a number of undifferentiated players and ultimately product commoditization – a first-to-zero race in which the only thing that sets manufacturers apart is lower prices, destroying margin profiles and the attractiveness of an investment. The sole comfort is that the behemoths in this space are only around $10bn in market cap, so it’s still a very fragmented space with lots of potential room for businesses to find some sliver of market share.

As far as SupremeX’s industry, I can’t give it a great grade – they rate better overall for having a leadership position in envelopes, but being unable to compare them directly with envelope competitors, intense competition in the packaging space, and the overall unattractiveness of the wider manufacturing industry makes this a fairly low rating.

Industry Grade: C+

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The Fundamentals

A microcap doesn’t necessarily mean a bad balance sheet – there’s a lot to like about SupremeX’s financial profile, and not a ton to dislike. Let’s dive into what they’re doing well before we get to the bad & the ugly.

Balance Sheet – The Good

Excellent & Improving Capital Efficiency Metrics

A company’s ability to generate returns on investments is everything – especially while monitoring their ability to expand into new markets and acquire businesses. Expanding capital efficiency metrics at this (crazy) pace across assets, capital, and equity over the last 5 years is super encouraging to see – it shows that SupremeX’s acquisitions across their segments are generating strong returns and that they’re able to find synergies between new businesses and existing operations.

EPS Growth

Through share buybacks and expanding operations, SupremeX has grown their earnings per share at a really impressive rate, an encouraging sign to investors. Even more encouraging is the fact that while the market cap has grown at an 11% CAGR over the last 5 years, EPS has grown at a 48% CAGR – indicating there could be a lot of value here on an earnings growth basis.

Margin Expansion

One of the things that keeps me from investing in manufacturing businesses is that they often end up with destroyed margin profiles from competition lowering prices to differentiate their products, forcing other manufacturers to follow suit – that race to zero I spoke about in the industry section.

But SupremeX sets themselves apart from a lot of other manufacturers by posting some really impressive margin expansion over the last 5 years, which indicates to me they may have some pricing power, and/or they’re making their operations more efficient, and/or they’re benefitting from economies of scale within manufacturing and distribution.

Decent Net Debt/EBITDA

Always something to watch out for with a business making lots of acquisitions to grow – if they over-leverage themselves, they may end up paying a greater price than they can afford in interest payments. Growth at whatever cost is not the sort of consolidation business you want to be invested in, so net debt/EBITDA is important to keep an eye on.

For the trailing twelve months, SupremeX’s net debt/EBITDA is sitting at 1.5x, a significant de-leveraging from the 3x figure they sported in 2019, though it seems to mostly hover between 1.5x-2.5x on a historical basis. This is a fairly conservative debt profile for an acquisition company and leaves a decent margin of safety to be able to repay their debts.

Steady Cash Flows

Free cash flow is really the north star for a business’s success – it gives a company the ability to further invest in the business without raising equity or taking on debt, buy back shares, pay dividends, or pay back debt. For SupremeX, cash flows are central to their growth strategy, so the 54% CAGR in free cash flows are a good sign that they will be able to continue to grow, buyback more shares to reward shareholders, and maintain a healthy balance sheet.

Balance Sheet – The Bad & The Ugly

Elevated Debt Profile

Though SupremeX manages a fairly safe net debt/EBITDA, their total debt is high relative to their market cap. With $76.9m in net debt in the last twelve months, SupremeX’s enterprise value nearly doubles its market cap of $113m. Compared to the total size of the cap, the debt levels may be a bit more concerning. I don’t see this as a blatant red flag, but total debt is something to keep an eye on along with other debt metrics.

Dividend

SupremeX’s dividend got slashed during the uncertainty of the pandemic, and though the company reinstated it a year later, they haven’t returned it to its previous level – from $0.26 /share and a 10.7% yield to just $0.14 /share and a 2.2% yield now. It was raised in the most recent quarter to that $0.14 figure from $0.135, so for dividend investors, that may be a good sign of a returning dividend.

However, I think whether the dividend not being back to pre-pandemic levels is a good or bad thing comes down to your perspective; personally, I see a declining dividend as a good thing because it means the company is seeing areas where they can generate high enough returns that paying a dividend isn’t worth it – in short, there’s more opportunities for the company to grow.

Mostly Debt Funded

About 58% of SupremeX’s capital structure is debt – in the current macro-economic environment, the debt levels may prove to hurt the company’s bottom line. This wouldn’t be very unsimilar to rival Cenveo, which had to declare Chapter 11 in order to reorganize its debts as a result of its over-leveraged position, and that was in a much breezier economy than SupremeX faces today. As a smaller company that may have less success raising equity funding, this is something to be particularly careful of with SupremeX.

Small Cash Position

Despite stable cash flows, SupremeX keeps a very small cash position of ~$1m. While this is good that they’re funnelling most of the cash flows back into the business immediately, this may leave them at risk of not being able to cover some small near-term surprises, such as goodwill impairment or needing to pay down some debt.

YoY Declines

While a lot of SupremeX’s metrics look fantastic when stretched out on a 3- or 5-year basis, their most recent quarter wasn’t a great one, and the company experienced a lot of YoY decline, leading to a nearly 30% drop in the share price. Net earnings, EBITDA, and cash flows were all down YoY, while SG&A expenses as a % of net revenues were up and the growth in operating expenses outpaced revenue growth.

A lot of this is less attributable to a terrible quarter this year, but rather an unsustainably good quarter this year – the company was benefitting from an enormous supply crunch in paper, which led to huge demand – their customers were buying as much product as they could get their grubby little hands on, and SupremeX was selling stock the second they had it off the press. This could not be expected to continue in the long-term, but the market got a little excited by the growth they were seeing in the business as a result and the shares got inflated as a result.

This year, SupremeX is facing the complete opposite – there is no longer a supply crunch, and the economy has tightened enough that many businesses are cutting costs wherever possible, leading to inventory sitting in a warehouse rather than flying off the press. Over the long-term, the growth in all of these metrics still looks fantastic, but the market got a little irrational both on the positive side and on the negative side – I expect shares will bounce back in a more stead fashion as growth is normalized.

Balance Sheet – In Summary

SupremeX is doing a lot of things right – while there was panic over the most recent quarter’s results, I think this is mostly unwarranted. Zooming out and taking a look over the long-term and understanding the reasoning behind the YoY decline shows there isn’t much cause for concern here, to my mind. And with that zoomed-out view, the patient investor can see the incredible strides SupremeX has made over the last 5 years.

The business has had incredible returns on their investments, improved their margins, and grown their cash flow and earnings at very impressive clips. If you’re a dividend-focused investor, perhaps you don’t like the nearly 8% cut in dividend yield since the onset of the pandemic, but this capital is going towards acquisitions and buybacks instead.

The only thing to watch out for with SupremeX, as with any consolidator but especially a micro-cap, is the debt profile. While net debt/EBITDA looks great, the amount of debt relative to the size of the company may be a bit concerning, as is the debt-oriented capital structure of the company. Something to keep an eye out for.

Key Performance Indicators (KPIs)

The list of KPIs for SupremeX is short, but there’s still some important stuff to keep an eye on to make sure the company is not only growing, but doing so responsibly.

Days Inventory Outstanding

Days Inventory Outstanding just indicates the amount of time that it takes for inventory to be sold – a lower amount indicates the company is selling through inventory faster, meaning they don’t have to store it as long. It’s a useful efficiency metric for businesses that have to deal with inventory – unfortunately, SupremeX’s DIO has taken a sudden uptick from the ~53 days they usually hover around to around 66 days. Management commented this is due mostly to some cost cutting from their customers, a reason that has bled into a reduced volume of products being sold.

Volume

Volume is important to keep an eye on to make sure the products being sold aren’t declining materially over the long-term. Envelope volume declined nearly 20% in Q2, though this was offset by price increases that allowed Supremex to recognize some revenue growth YoY. This, again, was due to the unsustainable levels of manufacturing/sales in 2022, so I’m not concerned about this long-term – but it’s something to monitor for those looking to invest in SupremeX.

Packaging Revenue & Margin

Since the packaging segment is so crucial to the long-term thesis in this company, and such a potentially risky growth strategy as well, monitoring how revenue is growing from this segment will be important. Look for revenue growth above >15% to ensure this part of the strategy is going well, and monitor the adjusted EBITDA margin to keep an eye on whether they’re being impacted by competitive pricing.

Impairment from Goodwill

Just due to the number of acquisitions SupremeX is making, they carry a fair bit of goodwill on the balance sheet – $59.2m. This is completely normal and not actually a bad thing at all, but if they pay significantly over the fair value for an acquisition and the value declines, they’ll get hit with an impairment charge. Despite all the goodwill, SupremeX hasn’t been dinged with any goodwill charges in a number of years.

Defense & Offense

Geographic Expansion – Offense

Most of SupremeX’s business is concentrated in Eastern Canada and Northeastern U.S., leaving some pretty significant opportunity to expand the business into new markets. Their Quebec market is completely saturated, so they’re really reliant on new geographies for growth in envelopes.

The company is targeting the Midwestern U.S. for their envelope segment due to the high mail volumes and large customer base, but the Southern and Western markets are mostly untapped by either packaging or envelope segments by SupremeX – there’s been no commentary from management on the investment potential in these areas, and for at least the short-term they seem solely focused on the Midwestern and Eastern markets.

Acquisition – Offense

This ties into geographic expansion, but just continuing to acquire packaging businesses to get some foothold in that segment while also consolidating in the U.S. envelope market will be the main growth levers for SupremeX. As they acquire more, they should also continue to benefit more and more from economies of scale.

Packaging – Offense

I won’t ring the bell on this one too much more – though there’s some room for organic/acquired growth in the envelope segment as they focus on consolidation in the larger U.S. market, the real growth story is still in packaging. This will be a key growth lever for them to pull, though it will be interesting to see at what cost if their packaging products end up getting commoditized enough to damage the overall margin profile.

Distribution Network – Defense & Offense

This ties into economies of scale, but as SupremeX continues to make acquisitions, they should benefit from a wider cost effective delivery range, allowing them to provide cheaper prices to their customers while maintaining margins. This could protect their market position as a provider of choice with existing customers while also attracting newer customers that are simply looking for the cheapest offer.

Dying Industry – Defense

It takes a lot of capital to get started in a manufacturing business, especially when you consider more custom offerings such as SupremeX’s custom envelope products, which require much more complex infrastructure to meet specific customer needs. While this isn’t such a huge barrier in a high-growth industry like packaging, few businesses are going to make the investment to enter an industry in secular decline.

The lack of players in the space creates a pretty limited field of choices for customers in need of envelopes, allowing SupremeX to maintain steady customer relationships and a brand reputation within the industry that will help them to maintain and even grow (branding is very important to effective consolidation) their market position.

Fundamentals Grade: A-

The Investment

Now, to the really important part – a terrible business can still be a good investment if it’s cheap enough, and a brilliant business can be a bad investment if it’s expensive enough. So where does SupremeX sit on this spectrum? Well, we’ve covered the business, balance sheet, industry, and management team – they’ve scored mostly well in everything except on industry, so the business’s potential is there. Let’s see about the investment potential.

Valuation

Based on TTM figures:

EV/S: 0.7x

P/S: 0.37x

P/E: 4.37x

EV/EBITDA: 3.6x

FCF Yield: 23%

Cheap. Extremely Cheap. Especially when considering this is a business that grew revenues at 24% on TTM figures. Now, investors have to consider the contribution of YoY declines in cash, margins, and volume that is partly responsible for making this stock so cheap – but zooming out beyond an unsustainably good year that makes for a nearly impossible comp, it potentially provides a bargain.

Looking at historical valuations, the P/E ratio is significantly below 5-yr averages of 6.3x. The P/S ratio sits at exactly its 5-yr average of 0.4x, though revenue growth has ramped significantly in the last few years while the P/S remains mostly unmoved, which doesn’t seem to reflect the growth. Finally, the 23% FCF yield is well above the 5-yr average of 11%, which would suggest this is extremely cheap on a free cash flow basis despite the growth in free cash flows – something management seems to agree with considering the recent announcement of a buyback on 5% of outstanding shares.

That is the beauty of a microcap Canadian play that just had a bad quarter – you get the triple whammy of a company being underappreciated by pretty much every institutional investor and many retail investors as well. This simply isn’t a name that a lot of investors are paying attention to at the moment, and that provides potential value.

Forward Valuation

I’m going to map out two projections here with some back of the napkin math.

I Hate Microcaps Model

For a full 5-yr holding period:

• I assume a 4% CAGR in the envelope segment through to 2028, as the company slows in acquisition rate and the industry continues to decline.

• The packaging segment grows at a steady 15% CAGR through to 2028.

• The dividend remains unchanged at $0.14.

• Net income margins recover somewhat from Q2 ‘23, but remain at historical levels of ~6.9%.

• P/S ratio declines from their historical averages to 0.3x and 4.5x, respectively.

• 5% of shares outstanding are repurchased and retired, giving the company 24.6m total outstanding shares.

• This would have the company making $453m in revenues and $31.3m in net income by 2028, giving EPS of 1.3.

  • At a P/E of 4.5x and EPS of 1.3, the price per share would be $5.85. Including the $0.14 annual dividend would effectively make it $6.55, giving shareholders an 8.4% CAGR from current prices – a pretty dog investment if an ETF can generate ~10%.

Cautiously Optimistic Model

Let’s say things go better. For a full 5-yr holding period:

• I assume a 6% CAGR in the envelope segment through to 2028, as consolidation in U.S. continues along steadily.

• The packaging segment continues to grow nicely at a more solid 18% CAGR.

• The dividend remains unchanged at $0.14.

• Net income margins recover well from Q2 ‘23 and return to averages from last eight quarters of 9%.

• The P/S ratio remains at historical average of 0.4x while P/E ratio falls below historical average but remains at 5x.

• 7.5% of shares outstanding are repurchased and retired, giving the company 23.96m total outstanding shares.

• This would have the company making $490m in revenues and $44.1m in net income by 2028, giving EPS of 1.84.

  • At a P/E of 5x and EPS of 1.84, the price per share would be $9.2. Including the dividend of $0.14 per share would effectively make it $9.9, giving shareholders a 17.8% CAGR through to 2028 – an easy market beater.

This is very back of the napkin math so don’t work this into your own models at all, and play around with the numbers if there’s any assumptions you don’t agree with. I’d lean more towards the optimistic model being more realistic here, as it’s still pretty conservative on the exit multiples and almost definitely do-able as far as growth figures and share repurchases go.

The main thing will be whether the company can maintain net profit margins at a higher rate – if they face commoditization in the packaging segment, this may be hard to keep at a ~9% figure, which would significantly change this model.

Analysts

Out of 4 analysts, the average 1-yr price targets are looking pretty optimistic:

Low: $6.75 → +55.5%

Average: $8.06 → +84.4%

High: $9.00 → 106%

Interestingly, despite the huge potential returns that even the low target would generate, 1/4 analysts are rating the stock a hold at the moment, but it’s good to see that at least some institutional investors see the stock as a strong buy at current prices.

Usual disclaimer that these are analyst opinions – they are likely to be as wrong as anyone else and their outlooks are usually short-term oriented, so take their estimates (and all others) with a grain of salt.

Risks to Share Performance

• Margin Reduction from Commoditization

• Sustained Macro-Economic Pressures

Red Flags

• Terrible Glassdoor Ratings

  • Always tough to see. Never bodes well for overall effectiveness of management to create a positive work environment if people are that upset about working there. it’s more of an orange flag for the reasons I described in the Industry section, but I still hate to see it.

• Reporting

  • This is more of a personal ick with companies that don’t bother reporting some key metrics I’d like to see – specifically, SupremeX doesn’t report on specific organic growth figures, which is a great metric to see how companies are folding acquisitions under their wing. They also don’t report on segment revenues by geography, which would be helpful for monitoring the U.S. expansion story.

• Cyclical Business

  • They are very dependent on inventory and supply chains smoothness, and vulnerable to the same cyclicality as their customers – as evidenced in the current economic environment.

Green Flags

• Underlooked Investment

• Lots of Insider Buying

  • Great to see insiders so aligned with shareholders and obviously optimistic about the current valuation – all buys and no sells in last 6 months. This is a HUGE green flag!

• FCF Yield

  • One of my favourite valuation metrics, and it’s super high compared to normal/historical valuation – another big green flag on valuation front.

Investment Grade: A

Share

The Short Story

SupremeX is a very interesting story.

Not an interesting business – that’s about as boring as they come. But a potentially interesting story for investors to keep an eye on, for sure.

The company has a steady business model (even if it is a manufacturer) and a two-pronged expansion strategy that relies on the expertise, leadership, and cash flows coming from their dominant position in a dying industry to fund a risky, but potentially intriguing, expansion into a growthier market.

And while there are certainly synergies between the newer packaging market and the dying envelope segment, only time will tell if they are able to buy their way to significant success in this market, or if the commoditization curse of manufacturers will make management rue the day they set their eyes on packaging.

The management team is experienced and responsible for the so-far successful implementation of SupremeX’s business pivot – but they too come with some risk. Age may not keep them working at a plain jane envelope and package manufacturing plant for much longer, while the burn rate on CFO’s may indicate a deceptive but more sinister underbelly to this business.

As risky as the team may or may not be, they certainly can’t be worse than the industry – ironically, SupremeX’s leadership within an industry experiencing secular decline saves them from getting a bottom-tier grade on this front. The potential margin pressures and intense competition in a market they haven’t proven themselves that makes the industry the highest-risk part of this entire story.

Still, the investment may be cheap enough to warrant the risk – at the very worst, the stock is on par with historical valuation levels, but at many points looks to be significantly undervalued, particularly on a FCF yield basis, my own north star valuation metric. There are potential returns here for the brave and patient investor, but it’s not without risk – as a Canadian microcap without much institutional interest, and coming off a bad quarter to boot, SupremeX doesn’t have a huge support to lean on. If they find their balance sheet over-leveraged, aren’t able to maintain a healthy balance sheet due to goodwill impairment, or get caught with their pants down from a small cash position, they could be in for a long slow spiral that would not be enjoyable for investors.

Proceed at your own risk. I personally believe the green flags around the investment and the current valuation, alongside management alignment, makes this a pretty attractive investment, but lord knows I’ve been wrong before. Q4 is typically the strongest quarter for the business, so now or after Q3 results may be when I look at getting in. Now, let’s hand out the final grade:

Report Card

Final Grade: B+

That’s all for SupremeX folks. Love to hear your thoughts on the business, potential return, whether you’ve heard of the biz before – anything really. So leave a comment on the post, and if you want to share it with a friend it’d make my whole day!

I’ll be coming back at you with another deep dive article on XPEL in a few weeks, so stay tuned for that!

Happy investing.