Market Insight: A rally by DSV, but is it hype or hope?
DSV’s interim numbers this month were nothing short of exceptional, but several risks could spoil ...
Ever heard of the law of unintended consequences? Denmark’s DSV is running the risk of delaying a key corporate decision: its next M&A move.
And there is obvious downside in this waiting game.
If it waits any longer, this could hinder its performance on the stock exchange, just as it did – in terms of incremental returns – during the years that preceded its $1.35bn acquisition of US-based UTi Worldwide.
To paraphrase the thinking of several of my banking sources, many of whom have ‘skin in the game’, management has been incredibly quick to talk about deal-making after UTi was integrated, yet painfully slow to act since.
However, as the table above shows, there was no disappointment whatsoever in its latest trading update, which was boosted by the announcement of a Dkr1.1bn ($176m) three-month share buyback programme.
The successful integration of UTi was a masterstroke, contributing to significant value creation while giving the 3PL a wider geographical reach and stronger economic moats.
Yet in the six months ahead of first-quarter results, the stock traded sideways, and that came as expectations for M&A remained very high, but no formal announcement was made.
Aside from institutional investors carefully monitoring the situation – “not ready to bite here, it’s crazy”, one cash equity trader in London commented this week – some bargain hunters have recently voiced their concern about a valuation that is hardly justifiable “if management doesn’t strike a deal of a certain magnitude”.
The clock is ticking now, yet a scarcity of targets of a certain size might lead DSV to destroy value. How likely is that?
Another record high of Dkr543.6 in mid-May – the shares currently trade at Dkr541 – signals that a solid trading update and new buybacks were welcomed, but the risk could be now skewed to the downside if inaction prevails in a market where, alongside Expeditors and XPO Logistics, DSV stands out as one of the few asset-light businesses whose shares continue to defy the law of gravity, thanks to its promised growth prospects.
DSV is the most expensive of all: a comparison with this year’s underperformers, Panalpina, Kuehne + Nagel (K+N) and CH Robinson, make this even more startling.
Its stock trades at a premium against virtually all asset-light businesses on my radar, based on adjusted cash flow multiples: its implied forward multiples (EV/ebitda of 17.3x; ~ EV/ebit of 20x) are higher than those of Expeditors (EV/ebitda 14x; EV/ebit 14.9x), CH Robinson (EV/ebitda 13.9x; EV/ebit 15.3x), K+N (EV/ebitda 13.8x; EV/ebit 16.6x) and Panalpina (EV/ebitda 10.6x; EV/ebit 20x).
Operationally, DSV is, along with companies like Expeditors, among the best-run freight forwarders worldwide, so it doesn’t necessarily need to grow inorganically just for the sake of it. But look at the table below, which sums up its P&L performance since 2010. I have highlighted the key variables worth monitoring, going forward.
Beating Q1 17 numbers was relatively easy last month, but the next three quarters will be more challenging, although its guidance is reassuring and implies a decent growth rate at the high end.
However, a high-end growth rate of almost 11% annually is bang in line with its stock price appreciation so far this year, and obviously implies more downside if its trading multiples contract; this assumes investors might be less willing to pay up for earnings growth.
On the bright side, its net leverage testifies to a sound balance sheet and solid cash flows, which give it plenty of options with regard to capital deployment in the $100m-$300m range, as its latest buyback proved.
Just a nuisance?
DSV is exceptionally good at managing expectations, but does this sound like the tail wagging the dog? The better it performs this year, the harder it will be to beat expectations next year without M&A (meaningful acquisitions often cloud year-on-year comparisons, as it happened post-UTi).
Its core air and sea operations, which were responsible for almost 47% of group turnover in 2017, are at a critical juncture. Notably, while volumes in sea freight activities (typically more profitable in terms of gross profit (GP) per unit, rather than margins) might be close to topping out, its air freight business is similarly pressured when you compare the drop in gross profit ratios.
GP/tons and GP/teu ratios fell almost 5% in 2017 against the prior year, after a peak in 2015.
Moreover, on this basis, the fall accelerated in the first quarter, based on comparable figures.
As far as investment in core assets is concerned, employee numbers were flat in sea and air freight and road operations, but the headcount surged to 46,767 from 45,636 at group level (+1,131) in the first quarter since December.
Where to allocate funds for acquisitions is hugely important, and DSV this year said it was keen to bulk up its core air and sea freight business, but its own deal-making could have been pushed back by uncertainty in those end markets. Regardless of its own preferences, the road and solutions businesses continue to warrant attention, because investment in staff and portfolio diversification is likely the way forward.
Its next big deal, promised since early 2017, is in the making, I understand, and ultimately it could be announced in the fourth quarter. Could it be a choice between acquiring a traditional freight forwarder – just as it did with UTi –or pushing for innovation through the information sector?
I don’t know, but the latter option could be dictated by market trends, where disruptors are trying to provide more transparency to shippers’ daily trades in a logistics market where transparency has often been perceived as an enemy, rather than ally.
That said, I am happy to speculate that it would make a lot of sense for DSV to team up with XPO and bid for CEVA Logistics, retaining the freight forwarding activities of the latter and offloading the contract logistics business to XPO.
But much depends on CEVA’s new shareholder, CMA CGM, which might have very different ideas.