Market insight: transport and logistics stock prices shrug off mixed margins
“The Dow theory … says the market is in an upward trend if one of ...
The D-Day scenario I hinted at in my recent coverage of two of the major ocean carriers worldwide was nowhere to be found in the latest trading update of Deutsche Post-DHL, which is closely watched when it comes to predicting global consumer trends.
It noted one month ago – see page one here – that global economic growth “picked up again slightly at the start of the second half of 2017”.
Notwithstanding doomsday, and regardless of growth prospects over the short-to-medium term, does its global portfolio of assets need surgery?
Let’s look at how it fared in the first nine months of a year that was broadly expected to be transitional for the German logistics behemoth. It could well be a year to remember.
While the rise in its stock price has left me in awe (+30% this year, or over €10bn in additional stock market value to €49bn) and it is remarkable that all the right financial and operational metrics are in good order at group level. I am starting to feel as if management had so many options at their disposal that more value creation could be on its way – based on the crucial assumption that global economies do not tank overnight, which seems fair.
Earnings per share continued to grow this year, despite some structural problems in certain parts of its portfolio, while cash flows were so good that rising net leverage almost passed unnoticed on a first glance – after all, its balance sheet is comfortably strong and relief was offered to cash flows, as capital expenditures (capex) sat “below [a] strong prior-year level”.
It will take time for its capex-light freight forwarding unit (DGF, 24.1% of group sales) to heal. But I have already addressed what I think are the critical issues – see here and here. Clearly, DGF deserves more time to deliver and, even if it doesn’t deserve it, management will give it that time; so, the jury is out, but newly installed experienced leadership is hardly a bad sign.
More importantly, it would be unwise to give new DGF chief executive Tim Schawarth a hard time. We may well be positively surprised as early as next year, when the key metric – upon which, incidentally, Mr Schawarth should be judged, in my view – is operating cash flow intensity.
Now, the really good news.
In the first nine months of the year, a 7.5% aggregate ebit margin in the core Post – eCommerce – Parcel (PeP) segment was only 10 basis points lower than one year earlier.
Increased material and labour costs and investment in the network, it said, “prevented a more significant improvement in earnings”.
Despite a diverse geographical portfolio on a consolidated basis, where turnover generated abroad stood at 70% of the total, Germany remains the main driver of growth for PeP, where it represents 29.5% of group total sales.
Given the systemic shift new technology has caused, postal trends have been appalling for some time, globally, but DP-DHL is holding up relatively well, I’d argue. There have been some seasonal adjustments, as the chart above shows, and what it is losing on one side of the trade it is gaining on the other, with rising quarterly cash flows being another improving sign of financial health.
“In the DHL eCommerce business, revenue was €1,113m in the first nine months of the year, exceeding the prior-year figure by 12.7%. Excluding currency effects, growth was 12.8%,” it said.
Given its ties with JD.com, among others, the expansion plans of the Chinese e-commerce platform could provide a clue about what to expect in 2018 and beyond, while seasonal headwinds experienced by others in the e-commerce trade may even be an opportunity, rather than a threat.
In this context, I also applaud the launch of first electric delivery van, with Ford, which reportedly “could save five tonnes of CO2 emissions annually”.
That may be a drop in the ocean, but it is also a step in the right direction; in the PeP unit, the largest capex portion was attributable to its global parcel network as well as the production of StreetScooter electric vehicles.
Heavy investment rose from a low base in DGF (to €52m from €37m), but if we consider all the units that count currently in terms of earnings power, PeP was the only one where capex rose in the first nine months of 2017 (to €346m from €327m), while the most capital-intensive division, Express, absorbed €444m vs €621m one year earlier – although some Spanish and Portuguese operations were reassigned to PeP from Express.
Could a digital shift mean lower investment requirements in future? I don’t know, but I have to admit there are signs DP-DHL knows exactly what it is doing.
The supply chain within
Itself a supply chain within the supply chain, other units rely on PeP’s strength, but Express (almost 25% of group revenues) is another key value-driver – and it is also on a roll.
It is growing globally, with clear benefits for cash flows.
All key performance metrics rose, too.
Finally, supply chain activities (just over 20% of total sales) are doing well outside mature markets, where the gains mitigated the pressure it felt in the Americas and EMEA.
Notably, this year it wrapped up additional contracts, “worth around €895m”, with both new and existing customers, which points to the attractiveness of those ancillary operations that almost function as a sort of glue in such a wide portfolio.
It said “the automotive, consumer and retail sector accounted for the majority of the gains”, while the “annualised contract renewal rate remained at a consistently high level”.
Where we stand
More broadly, it signalled caution rather than a buoyant outlook.
It said “in Asia, growth remained robust overall”, with the Chinese economy remaining stable. The Japanese economy continued to record moderate growth.
In the US, “the economic upswing remained solid, driven primarily by private consumption”, which, as I have previously pointed out, is surging at a fast clip.
“The upwards trend in gross fixed capital formation continued”, but there are also the macroeconomic considerations which make me feel less comfortable with logistics.
“The US Federal Reserve left its key interest rate at between 1% and 1.25% after having increased the rate in two steps by a total of 0.50 percentage points in the first half of the year.”
As I recently argued, this has led so far to a tightening of the spread between the yields of long- and short-term US Treasuries and those of other sovereign debt, which had some speculating – including me – about a worst-case scenario just around the corner.
If I am right, shippers would inevitably experience pressure on prices (this has been a threat for some time) and volumes (this could be the new reality); the freight forwarders would have mounting problems with margins and collecting credits more rapidly (it has been this way for some time); while tight capacity in air could soon be a distant memory and freight overcapacity the new reality, not only in the ocean trade (already the new reality).
And that can be scary stuff.
On the wrong page?
“In the eurozone, economic growth remained brisk. Private consumption and capital expenditures boosted domestic demand significantly again,” it said, but that strength brings currency headwinds.
Consolidated revenues were over €43bn, but “negative currency effects reduced the figure by €631m”.
It also noted that “exports continue to perform well and the rate of inflation stabilised at a moderate level”, which means upwards pressure on costs, more than benefits in sales and earnings, will likely persist along the supply chain.
“The European Central Bank kept its key interest rate at 0% and continued its bond-buying programme as planned,” it concluded.
To my mind this is the ‘sword of Damocles’ hanging over its core markets, as higher rates could deter consumer spending, particularly if the ECB pays little attention to the speed at which it withdraws the financial stimulus.
At this point, I sympathise if you think to have landed on the wall of a banking website rather than on The Loadstar, but frankly these are important matters.
How it plays out, if you listen to DP-DHL, however, might be less important than having the house in order when the inevitable, cyclical dip hits. And on this basis, it could well continue to shine on the stock market, although most analysts think its shares are grossly overvalued.