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In one of the imaginary conversations I recently had with my psychotherapist (far cheaper than the real thing), I couldn’t refrain from asking her whether there was any chance that Deutsche Post DHL’s global forwarding unit, or DGF, would be sold, despite repeated denials from management, which are adamant this business can be turned around, and is not on the block.
Is this not, I asked her, a classic case of cognitive dissonance?
Because I have a gut feeling this story has more to offer, after speaking to a senior M&A banker this week, who told me: “Give it time, and all the pieces will fall in the right place.”
And there were warnings signs in DP-DHL’s latest trading update that spurred my imagination.
Much to my amusement, in the wake of first-quarter results last week, came some soft criticism from the sell-side, in the form of an unedited note sent to investor by a French broker, who forced me to learn about certain achievements of DP DHL in the early hours of the morning, spoiling that time when I’m usually enjoying my morning tea.
I had to share that disappointment and couldn’t help myself from emailing a transport and logistics veteran, who worked for DGF until a few years ago,
“Hi, another disappointing quarter for DGF,” I wrote.
As a matter of fact, given the headlines that preceded the announcement, DP DHL has once again proved that it is not particularly good at managing expectations.
Here is an excerpt of the broker’s note contained in the body of my email:
“First-quarter EBIT -3% versus consensus, driven by Forwarding. 2017 outlook unchanged other than the tax rate, which is now expected to be 15% (vs. 19% previously). Importantly, 2020 guidance also confirmed.”
It added (in broker-speak):
“Forwarding/Freight: Q1 EBIT of EUR40m light versus consensus of EUR61m. Down YoY versus EUR51m in Q1 2016 – a disappointment versus the excellent performance reported for 4Q16 (EBIT 104m). Volume growth remained strong in both Air (+14% YoY) and Ocean (+6%), and GP/Tonne was also strong at EUR389 (+7% vs. EUR363 in Q4). GP/TEU of EUR212 was light, however, -8% vs. EUR231 in Q4.”
So, could $300m of annual EBIT be an overly ambitious target for DGF these days?
By way of reference, it fell just short of that amount in 2016.
My source reminded me that only a couple of years ago, DGF had an ambitious annual EBIT target of €750m.
As it turned out, in the past three years its normalized EBIT has been much, much lower than that, even excluding certain adjustments due to write-downs stemming from the infamous IT fiasco in 2015, and anything over €450m seems a stretch in this market over the medium term.
Moreover, its worldwide dominance is jeopardised by surging competition and disappointing profitable growth prospects.
Volumes are broadly ok but pricing is not, and how much it can charge clients for its services also depends on the volatility of its end markets.
And then enter from stage left the very bad news that many observers seem to overlook.
The volume-pricing mix strikes me as being an issue in a market where the demise of a slew of retailers in the US and elsewhere ought to remind us of the perils of either not having a properly diversified portfolio of verticals, or a too diversified and cyclical portfolio of verticals.
Noticeably, DP-DHL’s supply chain unit, which caters to end markets that could offer more downside than upside going forward, is the backbone of its services to shippers, and serves as a relationship glue with clients.
“In the supply chain division, the majority of funds was used to support new business, mostly in the Americas and EMEA regions where we made notable investments in the consumer and retail sectors,” it said in its latest update.
The consumer sector is in consolidation mode, as proved by latest rumours on a possible takeover of Colgate-Palmolive, whose market cap is a whopping $66bn, while the automotive industry will plateau at best in the mid-term in the US, while the European and Chinese auto markets offer a mixed outlook.
And then there’s the technology sector, where the fight between Apple and Qualcomm has heightened disruption risk in the supply chain.
These four sectors make up three-quarters of DP DHL supply chain’s business, as the table below shows.
The market leader in air freight, DP-DHL closely trails Kuehne + Nagel in ocean freight; its management must have noticed that its Swiss rival is looking to grow inorganically.
DP-DHL is effectively a state-run company, and as such is unlikely to entertain a radical overhaul of its corporate tree anytime soon, although management changes at DGF last year made me think otherwise.
All this comes as its stock trades close to early 2015’s levels, and there are signs the shares might have topped out after a plunge on the day its first-quarter results hit the wires. Its stock has yet to recover.
Management in Bonn should feel a sense of urgency, I believe, especially considering the operating performance in the remainder of its portfolio as well as certain news according to which the company is under threat from the unions over job losses and cuts to healthcare in the UK and US.
The full note from the French broker painted a picture of a stable conglomerate where traditionally best-performing units such as PeP reported EBIT some 3% lower than consensus estimates; EBIT was marginally higher year-on-year, but EBIT margin was lower, down 38 basis points on a comparable quarterly basis — mail communication volumes continue to decline, unfortunately, although domestic parcel volumes rose.
Moreover, operating profits at express and supply chain where just in line with expectations, and they are all more profitable than DGF – ultimately, it is the unit that could really move the needle when it comes to strategic decisions.
My source would agree that DGF’s cost base could easily become lighter, particularly when it comes to hefty costs associated to 42,900 staff, given the structural inefficiency that characterises how business is done, particularly in the Middle East.
“There are things that DP DHL has done well in recent years, but DGF arguably remains problematic,” another senior transport advisor in London added this week.
Although it doesn’t absorb a huge amount of capital, DGF greatly dilutes group margins, and it is responsible for a large chunk of revenues. In the first quarter alone, it turned over €3.3bn, or 22.5% of the group’s €14.8bn sales.
If it ever decided to shrink or to undertake a partial spin-off of the unit – the latter would make a lot of sense given the relative equity valuations of major freight forwarders – it would have to show investors a leaner structure.
That would also favour a sale at a full price, at some point down the road.
My imaginary (or is she?) psychotherapist would probably agree.