HARTE-HANKS, INC. $26 (New York symbol HHS; Aggressive Growth Portfolio, Consumer sector; WSSF Rating: Average) helps companies identify and target potential customers, and works with them to develop an advertising strategy. Direct marketing provides roughly 60% of its revenue, and just over half its profit. The remaining 40% of its revenue comes from its shopper division. Shoppers are free, advertising-supported publications that the company mails to households in a particular geographic area.

Harte-Hanks is the largest publisher of shoppers in the United States, with nearly 1,100 weekly editions in California and Florida that reach over 12.8 million readers.

Harte-Hanks’ revenue rose from $917.9 million in 2001 to $1.14 billion in 2005, or 5.6% compounded annually. Profits grew at a compound annual rate of 13.1%, from $0.82 a share (total $79.7 million) in 2001 to $1.34 a share ($114.5 million) in 2005.

In the three months ended March 31, 2006, revenue grew 3.7%, to $278.3 million from $268.3 million a year earlier. Revenue at the shoppers unit grew 16%, mostly due to the 2005 purchase of a Tampa shopper newspaper for $61.7 million. However, revenue from direct marketing fell 3.4%, as the company completed a large contract in 2005.

Harte-Hanks’ first quarter earnings fell 5.2%, to $23.8 million from $25.1 million, partly due to higher paper and postage costs. New accounting rules that force companies to expense employee stock options added $1.8 million to Harte-Hanks’ costs in the most recent quarter. Per-share earnings were unchanged at $0.29, due to fewer shares outstanding.

Strong reputation attracts new clients

The company’s strong reputation in the direct marketing field is helping it win new contracts. For instance, it recently signed a deal to help the U.S. Postal Service increase first class mail volumes. This could lead to deals with other government agencies.

Harte-Hanks is also looking to generate more revenues from its current clients.

For example, it recently helped GNC Corp., operator of a chain of nutritional supplements stores, to expand customer traffic and sales by restructuring its internal databases. By improving the accuracy and quality of GNC’s customer data, Harte-Hanks helped GNC stop sending mail to incorrect addresses.

Thanks to the success of this project, GNC now wants Harte-Hanks to analyze its customer data on an ongoing basis and create new marketing programs.

The United States now accounts for 95% of Harte- Hanks’ revenue. The company aims to expand its direct marketing operations in Europe.

It just paid an undisclosed amount for a German software company that re-sells some of Harte-Hanks’ customer data management programs. The combination of the two companies’ products should make it easier to attract new clients.

Focus on small cities keeps costs low

The outlook for Harte-Hanks’ shoppers business is also strong. Unlike large newspapers, shoppers tend to focus on small cities and towns. This gives local merchants and other advertisers a cost-effective way to target particular customers.

The company will probably continue to expand its shoppers business, either through acquisitions or startups. It will likely choose areas close to its current operations. That way it can keep costs down by using its existing printing plants and delivery network.

Long-term debt is just 9% of stockholders’ equity, so Harte-Hanks can easily borrow more to fund new growth projects.

Its businesses require only modest investments in new capital equipment. That gives it more cash for stock buybacks. Since 1997, the company has repurchased around $780 million worth of its stock.

Harte-Hanks has increased its dividend each year since 1995. The current annual rate of $0.24 a share yields 0.9%.

The stock now trades at 18.2 times the $1.43 a share it will probably earn in 2006. That’s down from its p/e of 21 a couple of years ago. The stock is also reasonably priced at 13.7 times projected cash flow of $1.90 a share, and at 1.8 times revenue of $13.80 a share.

Vulnerable to an economic slowdown

Harte-Hanks’ exposure to volatile ad budgets increases its risk. Rising newsprint and postage costs could hurt profits at its shopper business. But we feel that the company’s strong position and growing reputation in both these niche industries helps offset these risks.

Harte-Hanks is a buy.