Analysis: Kuehne + Nagel on a slow path to value destruction?
There could something fundamentally wrong in an industry where the market leader and other players ...
While some parts of Deutsche Post-DHL continue to secure big wins that testify to the reach of the German behemoth, one of its flagship divisions, DHL Global Forwarding (DGF), remains an eyesore in its vast asset portfolio.
In particular, it is truly astonishing that DGF did not manage to buck the trend of declining cash flows in the first half of this year, despite a buoyant market for air and sea freight operators – not to mention its sales performance, based on trailing records.
DGF remains the world leader in air freight, both in terms of tonnes and revenues, and I believe its problems go to heart of the way many freight forwarders are managed, regardless of their size.
Woes, share price and loss leader
Freight forwarding woes for DP-DHL persist at a time when financial analysts are banging their heads against the wall to come up with fair value estimates for its stock, which currently trades at a record high of almost €38, having risen about 10% since its interim trading update was released on 8 August.
Freight forwarding activities did little, if anything, to contribute to that surge and, more broadly, it is evident that other units have contributed far more to shore up its valuation on the stock market since the credit crisis in 2008.
One of several examples in logistics of a share trading well above consensus estimates from analysts, DP-DHL has proved wrong many observers – including me who thought value creation needed a different narrative, let alone a different corporate strategy, since its shares traded in the low €30s at the turn of the year. To a different extent, the shares of Kuehne + Nagel, Panalpina, DSV, Expeditors and CH Robinson all trade at a premium against analysts’ consensus estimates, which for DP-DHL are shown in the table below.
Out of kilter
Earlier in May, I wondered whether DGF was out of tune, or just out of time, and once again it captured my attention a couple of months later following the release of financial details that were extremely disappointing in terms of cash flow generation, leading me to the conclusion that management might have accepted it as a loss leader among the group’s diverse and vast portfolio of assets.
In fairness, the performances of other divisions would justify such an approach, but either way, is there a quick fix? And is there anything that needs fixing?
After all, the bulls can point out that revenues rose strongly on the back of more favourable trading conditions in the first half, surging 6% year-on-year, which is broadly in line with the rise it recorded between 2014 and 2015, but that would a rather short-sighted take.
In fact, the first half of 2016 was particularly bad, so half-year revenues in 2017 looked better than they actually were, still well below prior years’ levels.
Here are half-year numbers, which show revenues of €7.1bn…
(I’ll joyfully talk about 1H 2011-2017 cash flows later, so cast your impatience aside and admire the bit highlighted at the bottom of the tables that follow, while paying more attention to its top-line performance.)
…while between 2014 and 2015 its top-line ranged between €7.1bn and €7.5bn…
… and again between 2012 and 2013 sale were well above the €7bn mark, so…
…we have to go back to 2010 to find a performance that was worse than the first-half this year.
One problem is that markedly higher freight rates do not necessarily convert immediately into higher revenues, because clients are locked in long-term contracts. Another issue at group level and by unit is the strength of its reporting currency, the euro, which has rallied hard against the US dollar and other major currencies since the end of 2016.
“Deutsche Post DHL Group increased its consolidated revenue by €1,634m in the first half of 2017 to €29,696m,” it said in its interim release. But “negative currency effects reduced the figure by €178m. 70.0% of consolidated revenue was generated abroad (previous year: 68.7%).”
DGF’s operating profitability fell significantly, and the damage was visible at cash flow level.
In the first half of 2017, it burned €100m in operating cash flow (OCF) and was deeper in the red after reporting €64m negative operating cash flow one year earlier. This is its worst first half-year performance in almost a decade.
Trends markedly deteriorated since €35m of negative OCF was recorded in 2015, which was only a minor improvement against one year earlier.
Freight forwarding activities have not returned to significantly higher normalised cash flows, despite some changes in the management team – which raises the question as to whether DGF is executing based on poor internal due diligence processes, which ultimately concerns and affects corporate governance procedures, and vice versa – internal due diligence affects corporate governance risk, while corporate governance rules also affect/determine efficient internal due diligence processes.
I have discussed this topic with industry executives recently and, unsurprisingly, DGF has a problem with its reputation within the freight forwarding industry, it seems. Surely the appointment of a highly skilled executive such as Tim Scharwath, who joined the DP-DHL board this summer, could help, but is not a panacea because he is not exactly a finance guy.
When I discussed financial performances and fundamentals as well as internal reporting duties with the chief financial officer of a tiny European forwarder, he kindly reminded me that: “We are much smaller than others but ours are the standards. Have you seen the internal reporting stuff of DGF? I have them in my drawer – they are dreadful.”
Others I recently talked to added that these results not only reflected a lack of efficient internal procedures at DGF, but across the entire industry “only a few players shine, trust me”, one DGF rival in air freight admitted.
On this matter, the chief executive of a public company that ranks in the top five by size, recently confirmed in a private conversation that internal due diligence standards and processes “are generally weak in the industry, and you have to accept that”.
“And DGF is no different,” he concluded.
This comes as many players are not looking to sell the traditional freight forwarding business proposition anymore, I am told, but rather end-to-end solutions boasting a new technology slant, while bringing a consultancy element to their offering to shippers.
If that sounds too good to be true, it is because it probably is. One senior consultant in logistics said “this is a story I’ve heard, too, but with the margin pressure we have witnessed and are witnessing (…) it is just like scraping the bottom of the barrel to find something new to sell to the shippers (…), something that is simply not there in first place”.
As far as I am concerned, I do not know how a consultancy business with underlying operating margins of between 3% and 7% could ever be considered by stakeholders as a sound proposition, but I would be glad to be proved wrong.
In all this, while most of my industry sources are now expecting third- and fourth-quarter numbers to be much stronger than first-half figures, and not only for DGF, my final consideration is that certain problems are more deeply rooted in the industry than I thought initially. And until they are not addressed, the sword of Damocles will continue to swing over many executives’ heads in the finance departments of smaller as well as larger forwarders.