For this week’s bond review, Durig looks at an issuer that provides services to banks and retailers around the world. Diebold Nixdorf (NYSE:DBD) provides end-to-end services, software and hardware for the banking and retail industries. Diebold has spent all of 2019 implementing its DN Now program, designed to increase efficiencies, decrease costs, and improve margins. With the release of its third quarter results, it appears as if the company is making progress towards these goals.
- Gross margin went up 350 basis points to 25.5%.
- Free cash flow in Q3 was $65 million. In addition, the company has raised its 2019 free cash flow guidance from modestly positive to a range of $70 million to $100 million.
- Through its DN Now program, the company projects annual savings by the end of 2019 of $175 million.
- Q3 gross profit increased $42.6 million year-over-year.
With the world increasingly moving toward electronic banking, online shopping and mobile transactions, companies like Diebold Nixdorf are in an ideal position to benefit from this development. Its 2024 bonds, couponed at 8.50%, are trading at a discount, giving them a very competitive yield-to-maturity of more than 12%. Adding these Diebold Nixdorf bonds to Durig’s FX2 Portfolio adds the lucrative retail and banking industries to the portfolio along with providing excellent portfolio diversification. In light of the Diebold’s excellent third quarter results as well as its successful DN Now program, these bonds make an excellent addition to Durig’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
Diebold Nixdorf Reports Third Quarter Results
Diebold Nixdorf registered some solid wins in its third quarter (three months ending September 30, 2019). The company saw increases in its free cash flow, net cash provided by operating activities, gross margin, as well as adjusted EBITDA. Highlights from the third quarter included:
- Net cash provided by operating activities was $75.0 million, an increase of $190.5 million as compared to third quarter 2018.
- Free cash flow for Q3 was $65.1 million, an improvement of $190.5 million year-over-year.
- Adjusted EBITDA increased by 5.6% year-over-year, from $93.0 million in Q3 2018 to $98.2 million in Q3 2019.
- Gross margin increased by 350 basis points in the third quarter to 25.5%, the best performance since the combination of Diebold and Nixdorf in 2016.
- Gross profit increased from 228.9 million in Q3 2018 to $271.5 million in Q3 2019.
Diebold Nixdorf also had significant business wins in the third quarter, including:
- Renewing a multi-year managed services contract with H&M, a global fashion retailer, providing an integrated solution supporting its global stores with an all-in-one POS system, DN Vynamic Software and DN AllConnect Services.
- Reached an agreement with Dave & Buster’s, a leading U.S.-based dining and entertainment chain, to provide a self-service solution at locations nationwide, built around Diebold Nixdorf’s newest K-two interactive kiosk
Gerrard Schmid, Diebold Nixdorf president and CEO, commented on the company’s third quarter performance:
“The company’s third quarter results reflect solid execution of our DN Now transformation efforts. Operationally, our strategic focus on profitability is paying off, with solid gross margin gains across the board in services, products and software.”
About the Issuer
Diebold Nixdorf is a world leader in enabling connected commerce through automating, digitizing and transforming the way people bank and shop. The company’s integrated solutions connect digital and physical channels conveniently, securely and efficiently for millions of consumers every day. As an innovation partner for nearly all of the world’s top 100 financial institutions and a majority of the top 25 global retailers, Diebold Nixdorf delivers unparalleled services and technology that power the daily operations and consumer experience of banks and retailers around the world. It has a presence in more than 100 countries with approximately 23,000 employees worldwide.
DN Now Transformation Plan
Late last year, in the wake of some less than stellar quarterly results, Diebold Nixdorf unveiled what is nothing less than an overhaul of the company’s operations and cost structure. The DN Now program has been designed to simplify Diebold’s operations (everything from payroll to real estate) and optimize its expenses (vendor management, supply chain management). Key parts of the plan include:
- Implementing a customer-centric operating model which is projected to save $100 million annually.
- Divest non-core businesses. These currently amount to between 5 percent and 10 percent of total revenues. Proceeds from these sales will be used to reduce debt.
- Streamline solutions to reduce delivery cycles and improve supply chain performance.
- A comprehensive plan to improve services delivery and efficiency as well as targeted investment in next-generation solutions to enhance competitiveness.
The objective and goal of the DN Now program is to deliver $400 million in annual savings through 2021. Diebold expects to end 2019 by having implemented process changes that will result in $175 million in annual savings.
Financial Transaction Services Industry
One of the services Diebold provides to its banking clients is payment processing. This is a rapidly expanding service in the banking / financial services industry. A recent report completed by McKinsey & Company details the global growth of payments as illustrated here.
The report also provides the current state of payment processing in different global regions, as well as projections for growth.
- Global payments revenues are projected to approach $3 trillion by 2023.
- The Asia-Pacific Region now accounts for more than half of the global payments revenues, around $900 billion.
- Global digital commerce exceeded $3 trillion in 2017 and is projected to more than double by 2022.
- Rising smartphone adoption, increased online shopping and improved bandwidth coverage will continue to drive mobile commerce. In 2017, mobile commerce accounted for 48% of digital commerce sales globally and is forecasted to reach 70% by 2022, to approximately $4.6 trillion.
With Diebold’s global presence, the company is well-placed to benefit from the growth in global payments.
For bondholders, it is important to consider an issuer’s liquidity and interest coverage ratio. Adequate liquidity allows an issuer to cover operational expenses and interest payments in the event that it does not generate adequate cash flow in a given quarter. As of September 30, 2019, Diebold Nixdorf had a total liquidity of $680 million, comprised of nearly $250 million in cash and the balance available under the company’s available credit.
Interest coverage is an indication of the company’s ability to service its existing level of debt. For the nine months ending September 30, 2019, Diebold Nixdorf had operating income of $177.3 million (without non-cash depreciation expense of $171.3 million) and interest expense of $153.3 million for an interest coverage ratio of 1.1x. Investors might also note that for the third quarter, Diebold had net cash provided by operating activities of $75 million and third quarter interest expense of $52.5 million.
The risk for bondholders is whether Diebold Nixdorf can continue to drive improvements in its margins as well as continue to decrease costs. Through its DN Now program, the company has had good success thus far in reducing its expenses as well as increasing its margins. Another good sign for the company came in the form of amending and extending its $787 million revolving credit facility during the third quarter. On its last earnings call, the company has projected revenues will be flat in 2020, but also commented that it believes it will reach its DN Now goal of $400 million in annual savings by the end of next year. If the company can continue its trajectory of improving margins and increasing free cash flow, the risk for bondholders should decrease.
Generally, there is reduced risk for investors who invest in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio due to its diversification across many bonds and industries, as compared to the purchase of individual bonds. Historically, the FX2 Portfolio has significantly outperformed when compared to portfolios where investors have chosen bonds individually.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
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Summary and Conclusion
Diebold Nixdorf has been working diligently to reduce costs and improve margins this year. The company has been increasing its free cash flow generation and continues to add to its business wins. Also, global growth in the financial transaction industry is projected to grow robustly over the next three to five years, giving Diebold good prospects for increasing revenues and profits. The company’s 2024 bonds, with a yield-to-maturity of over 12%, provide investors with a fantastic opportunity to diversify their portfolios through the addition of this financial services / banking company. Given Diebold’s improving margins and cash flow, these bonds make an excellent addition to Durig’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio.
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Issuer: Diebold Nixdorf Inc
Ratings: B3 /
Price: ~ 87.1
Yield to Maturity: ~ 12.4%
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Disclosure: Durig Capital and certain clients may hold positions in DBD’s April 2024 bonds.
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