Analysis: CEVA wants a happy ending, and you can take that to the banks
Over the past few weeks I have had a number of conversations concerning the future ...
Thomas Cullen, chief analyst at Transport Intelligence, recently wrote that “keeping Frank Appel as CEO is in line with the emphasis on stability characteristic of DP-DHL over most of the past decade”.
“However, as the structure of the global logistics market changes, perhaps Mr Appel will have to display the sort of initiative seen at PeP [Post, e-commerce Parcel division] to other parts of the group,” he added in mid-December, after the news emerged that his employment contract had been renewed until October 2022.
My first thought is that Mr Appel’s destiny at the helm of DP-DHL hinges very much on inflation prospects – not only in Europe, of course, given the group’s global footprint and the competitive forces that characterise the global logistics industry these days.
As far its cost base is concerned, oil-driven inflation may not be a great thing to deal with in the near future, but for a couple of years or so it could help the freight forwarding business secure more lucrative wins with clients, given that fuel surcharges are expected to increase, among other obvious benefits – to forwarders at least – that the Trump trade could bring.
By pure coincidence, Mr Appel unequivocally denied even entertaining the possibility of selling the DHL Global Forwarding unit (DGF) one month before Amazon moved to buy a stake in ATSG, and then later also invested in Atlas Air.
He said at the time: “There were no [sale] discussions; and there will be no discussions. We will improve the performance of the [forwarding] division and we are very confident that we will make that happen.”
The threat posed by Amazon notwithstanding, Mr Appel and his board could grab the opportunity to lead the pack, showing major global rivals UPS and FedEx whether it makes any sense to continue with the conglomerate structure that has weighed on the value of DP-DHL’s equity on the public markets since the business was IPO’d at the turn of the century.
Is it possible that a smaller DP-DHL could quench Amazon’s thirst for global expansion in supply chain services?
I don’t know, and more importantly, I wonder whether the German behemoth could actually afford a radical corporate overhaul.
In November 2014, I wrote: “Financial engineering is not necessarily the answer, yet the value of ‘express’ and ‘mail’ could be better preserved if the two divisions were spun off,” or separated, from the reminder of DP-DHL’s vast portfolio of assets.
As Mr Cullen pointed out last month, the stock performance – helped by benign trends in the stock markets globally – has been remarkable during Mr Appel’s tenure, yet “recently, although DP-DHL has consistently increased both its profits and the value of its stock, the latter has barely kept up with the German DAX index”.
Stock prices alone seldom dictate corporate strategy, but the shares arguably look fully valued – the analysts surely think so anyway, given a price target of €30.1 for most, according to Thomson Reuters consensus estimates.
Fundamentals, meanwhile, are still a mixed bag despite greater emphasis on rising profits.
The balance sheet is healthy, but it is the cash flow statements where things get really interesting.
Receivables fell €300m in the first nine months of the year – cash inflows were fully offset, however, by the rise in other current and financial assets.
Cash and cash equivalents, meanwhile, plummeted to €2.2bn from $3.6bn; total assets fell by roughly the same amount, and payables dropped by €1bn to almost €6bn.
Year-on-year comparisons for P&L items show decent trends in operating profits both before and after impairment charges – as you might know, fiscal 2015 proved to be particularly challenging due to certain one-off items, as the now infamous excerpt below indicates.
Unsurprisingly then, when all the changes in short-term liquidity are considered, net cash flows from operations plunged to just €514m from €1.1bn in the comparable nine-month period one year earlier.
Even before working capital adjustments, gross operating cash flow was down €224m to €1.3bn in the first nine months of the year, despite fast-growing earnings (up 92% to €1.9bn) on a reported basis, and more encouraging trends in the third quarter.
Meanwhile cash outflows from investment grew 14% year-on-year to more than €1bn, which implied core free cash of €250m that fell to minus-€543m once working capital changes were factored in. On that basis, its adjusted cash-burn rate was €1.98m a day in the first nine months of the year.
Other accounts show that DP-DHL is paying less in dividends and more on stock buybacks, but yearly cash balance changes in the first nine months of 2016 also indicate that it is serious about delivering value to shareholders.
Nonetheless, if this is the zenith for the stock, Mr Appel will need to decide where to take it next.
A partial spin-off in the form of a 25-30% sale of existing DGF equity to current shareholders is a no-brainer for this enticing recovery story in 2017 – the unit reported the lowest level of underlying profitability among DP-DHL’s diverse assets portfolio, although it also absorbs the least amount of capital at group level, by the way.
Such corporate action would help it crystallise the value of PeP and Express as well as the DGF unit that in this buoyant stock market for freight forwarders could be worth over €5bn, in terms of enterprise value.
That assumes a forward adjusted operating cash flow (AOCF) multiple in line with Kuehne + Nagel’s 14x and annualised AOCF of €350m this year. As a reference, shares of other freight forwarders trade in a similar ballpark – generally 13-16x forward AOCF – while, by comparison, DP-DHL stock currently trades at less than 9x AOCF.
A €5bn-plus price tag – hardly justifiable 18 months ago – would represent up to 15% of the group’s entire enterprise value. In the first nine months of 2016, DGF was responsible for 22.8% of total sales, recording only 7.6% of group Ebit and constituting 10% of its global workforce.
While I appreciate DGF is not on the block, I maintain a partial or full divestment is an idea worth pitching to the board this year or next, although, admittedly, it will not come from a new chief executive, as I expected in March 2016.
Nonetheless, that would be financial engineering at its best – something its main shareholder, the German government, is particularly good at.