Analysis: A Japan Post merger with FedEx? Just dreaming... or am I?
Sometimes one has dreams that are so life-like that when you wake, you’re not quite ...
“We are committed to continuously reinventing ourselves for the benefit of our customers”, says Frank Appel in Deutsche Post-DHL’s annual results 2016
I had mixed feelings when DP-DHL released its annual results last week, but after digging beneath headline numbers that were broadly satisfactory across most divisions – particularly good for Post-eCommerce-Parcel (PeP) – I found myself becoming increasingly relieved to find clues that its capital allocation strategy is working.
It is also well balanced.
Are these key elements behind the rich emoluments its top executives receive?
DP-DHL is actively exploiting a still benign environment for fundraising, which helped it deal with a nuisance related to pension adjustments that hindered cash flows in 2016, while keeping dividend risk at bay and spending top dollar on shrinking the share count.
UPS was similarly affected by certain pension adjustments, its annual figures revealed – these and other one-off items seem to have become more difficult to manage, let alone to forecast. They pose a risk to global businesses, and materially hurt cash flows in DP-DHL’s case.
In fact, although its ebit was almost €1.1bn higher year-on-year, net cash from operating activities fell €1bn to €2.4bn – the decrease was fully due to the funding of pension obligations in the amount of €1bn, it said.
“Excluding this, net cash from operating activities was €3.44bn, in line with the prior-year figure,” it added.
Capital allocation concerns how much capital is invested in any business and in shareholder-friendly activities, as well as what kind of capital is deployed.
With regard to the latter, I am inclined to suggest that DP-DHL has set the roadmap to success for incumbents who are after shareholder value in the diversified logistics world. It entertained bolt-on deal-making in 2016, shying away from transformational deals, while other signs in its capital allocation strategy are reassuring at a time when global economies remain fragile.
With the prospect of higher interest rates and lower oil prices all too visible – “several uncontrollable elements keep many decision makers involved in logistics and transport awake at night”, one investment banker in London put it this week.
But the subtext from DP-DHL is unequivocal – we are experiencing short-term headwinds, which are here to stay; but we are fine, and we know how to deal with the problem.
What are the risks, though?
The company has the financial wherewithal to deal with unexpected events, and it already anticipates a reduction in liquidity in the first half of 2017 “as a result of the annual pension prepayment due to the Bundesanstalt für Post und Telekommunikation, as well as the dividend payment for financial year 2016 in May 2017”.
However, it forecasts a stronger “liquidity situation” around the end of 2017, due to the seasonal boost it usually receives during the holiday season.
What is remarkable here is that the Germans raised new debt last year to finance smaller acquisitions, near-record dividends and large buybacks, all without having to tap into a falling cash pile. Consider that the decline in cash and cash equivalents would have been €1.5bn- €2.1bn from €3.6bn (instead of a much smaller €500m drop to €3.1bn), had it not used external capital – by raising €1bn in debt – to support shareholder-friendly activity.
So, it is playing it safe, which is smart in this market.
Good time to refinance
Its net debt is manageable, given its implied level of net leverage at less than 0.5x and ample cash flows, yet some maturing liabilities must be refinanced.
While the amount it will likely borrow shortly should be material, the price it will have to pay to borrow, say, €1bn, will likely justify its decision to push ahead with large buybacks, while maintaining an appealing dividend policy (its forward yield is 3.5%), which has contributed to capital appreciation for shareholders of late.
In its annual release, it says that “in light of the fact that the bond issued by Deutsche Post Finance in the amount of €0.75bn will fall due in June 2017, we shall review the refinancing options available under the debt issuance programme and, if necessary, borrow funds on the capital market”.
In other words, it will very likely raise more debt at convenient rates, possibly within the next few weeks.
Is that the right thing to do, or is DP-DHL biting off more than it can chew?
At €1.23bn, net cash used in financing activities was lower than in the prior year, although through a bond placement in April it issued non-current financial liabilities which typically mature in more than one year, raising new debt capital that doubled its net debt position to €2.2bn. By comparison, that’s just about one-fifth of Maersk’s, although its ebitda is only one-fifth lower, at about €4.8bn.
Unsurprisingly, as DP-DHL notes, net cash used to purchase treasury shares surged “from €70m to €836m”, while at well over €1bn, “the dividend paid to shareholders was the largest payment item”. On top of that, the unwinding of interest rate swaps on outstanding bonds pushed down interest payments.
As it continues to target a payout ratio of 40% to 60%, earnings per share rose to a multi-year high of €2.19, but cash flow per share plunged by 28.5% to a four-year low of €2.03, due to its pension funding hurdles.
It could be just a performance blip, but it did not churn out much free cash flow (FcF), given a FcF yield that I estimate at 1.1% on a trailing basis – and that is why it used financial engineering to shore up its stock price, propelling a much higher pay package for its executives.
It might continue to do so. Certainly, another buyback programme could be on its way as the one announced last year draws to a close.
Funds from operations
“In light of the earnings forecast for 2017, we expect the ‘FFO to debt’ indicator to remain stable on the whole and do not expect the rating agencies to change our credit rating from the present level,” it stated.
FFO (funds from operations) is an internal measure of fund generation the company uses – it represents operating cash flow before changes in working capital, plus interest received, less interest paid, and adjusted for operating leases and pensions – think of it as similar to an adjusted EBT.
On a relative basis, the FFO-to-debt ratio was little changed year-on-year, as the table below shows.
PeP, of course, was the star performer, recording outstanding growth rates, while the express business also ‘delivered the goods’. The global forwarding and freight unit remained in limbo while the supply chain unit attempted a bounce on the road to recovery.
Top executives, as shown in the tables below, were rewarded staggeringly well in the wake of what I think was a decent performance in 2016.
Which doesn’t mean, of course, that more subdued financial metrics and capital appreciation trends would have left executives empty-handed, as the latest headlines from North America reminded us this week: “UPS gives top brass a raise despite missed targets”.