Analysis - declining cash levels could lead Maersk on a $5bn new equity quest
I have been thinking a lot about the cash and liquidity profile of Denmark’s AP ...
I once wondered whether Panalpina might ever find itself in a position in which it would have to compromise between the funds it allocates to headcount and those to dividends: now I know the payout is a top priority – at least until the end of this fiscal year.
This is not a trivial matter. Financial strength gives Panalpina options, but these are scarce at a time when the opportunity cost of deploying capital elsewhere must be gauged against the benefits of waiting for a better time to do so.
Somewhat sadly, transformational M&A is not something the industry is looking forward to, and while Panalpina is open to such talks, a deal must be crafted on its own terms, so investors’ appetite for the “PWTN” ticker might continue to hinge on the income associated with its cash flows.
In an interview with The Loadstar, chief financial officer Rober Erni was unequivocal when asked whether the Swiss forwarder could afford cash outlays of almost Sfr90m to pay this year dividends: “Yes of course, ever since we communicated the dividend strategy to the outside world, a predictable and stable payout ratio has been the story over the last four years. Things have not changed.
“We have a strong cash balance, which exceeds what we need to manage our business and the capex requirements (Sfr40.9m in the first nine months). We have used cash for M&A and there’ll be more to come. So, we’ll likely not be able to increase the dividend in 2018, but we’ll be able to maintain that level for another year, subject to AGM approval.
“Obviously, we then need to reach our financial targets and decide how to move on and how much to pay out, because in the past 24 months the payout ratio was above 100%,” Mr Erni concluded.
It is great to hear income investors should expect a dividend per share (DPS) of Sfr3.75 this year (which implies a rich forward yield of 2.55%, based on its current price), but what lies ahead could be even better – although there remains a possibility that the frothy valuations of almost all the major freight forwarders could struggle to defy the laws of gravity next year.
Before my analysis of some key P&L figures, here is an excerpt of a recent interview with the management team of Panalpina, part of which was published on 8 December.
How was the fourth-quarter performance in air freight and ocean freight activities?
Chief executive officer Stefan Karlen: “In air, the fourth quarter it is going the way we have predicted. Strong volumes, certainly stronger than last year, the strongest since 2008 in fact. Capacity is thin, and we have been very proactive about securing capacity beforehand and that obviously has played in our favour. Very strong demand for e-commerce has had a big impact on volumes, and consumer behaviour is driving all this.
“Ocean freight has decelerated a bit, as we have anticipated and see it, and given that the business is contracted yearly, there are opportunities but those are limited.”
Is there pressure on gross profit?
Mr Karlen: “Every year there is pressure in the fourth quarter, but on the positive side customers have understood this year it’s all about capacity, and they have engaged to pay higher rates. I’d say this pressure is better managed now than in previous years.”
Price hikes and your targeted sectors: who was willing to pay up?
Mr Karlen: “Customers in the technology, automotive, and consumer retail sectors stand out.”
How about earnings per share (EPS)? Should we expect this metric to be over the Sfr1 mark?
Chief financial officer Rober Erni: “Since we are not giving specific financial guidance, EPS consensus is always difficult to meet. However, the Panalpina equity story is not about quarterly earnings but about achieving a mid-term target as outlined last time at the capital markets day.
“We have been very transparent on what we can control, where we are making progress in respect of growth, but also about the targeted conversion ratio per product, which for instance for air freight is currently [in the third quarter] not very far away from the desired level.”
Cash flows fell in the first nine months of the year. What happened?
Mr Erni: “Whenever there’s growth in the business you will see an increase in net working capital impacting the cash flow.”
Guessing game time: are freight forwarders overvalued?
Mr. Erni: “If the higher valuation is driven by growth, particularly from the air freight market, then higher equity valuations will be justified.”
Thankfully the dividend is solid, but it is also worth looking at underlying trends for some of its key financial metrics to understand the kind of pressure it must withstand to support it.
(Note for the reader: Panalpina is not alone, of course, and these are challenging times for most freight forwarders globally, although the cyclicality of their clients and other strategic/financial considerations have determined differing outcomes on a quarterly basis.)
In the third quarter, personnel costs (the heaviest of all) rose for the first time this year, based on comparable quarterly figures for 2016, while costs of goods sold [COGS, or third-party transport services expenses] outpaced the growth of net revenues by 4.5 percentage points (9.7% growth for sales vs 5.2% for COGS) in the first nine months.
If the board approves a DPS of Sfr3.75, the dividend will be maintained at last year’s level, but surely it will continue to be a balancing act for costs of goods sold versus operating expenses through to 2019.
I still expect Panalpina to end the year with a gross profit of around Sfr1.4bn, or Sfr58.9 a share. With that, it must pay all its operating costs (I expect staff expenses at Sfr37 a share this year), the taxman and interest to the bank, which are pretty negligible.
Net sales in the first nine months of 2017 were Sfr3.86bn, or Sfr162.6 a share, with gross profit at Sfr45.9 per share, which, on an annualised basis, is just a tad over Sfr60 a share. This figure makes a lot of sense, given the previous Sfr1.4bn gross profit projection for 2017, and considering that gross profit in the first nine months of 2017 was Sfr67m lower than in the prior year.
Panalpina stock trades at 3x gross profit, which is a trading multiple out of fashion, you might argue, but already tells us the inherent business risk of freight forwarding activities over the medium term. Incidentally, consider that a multitude of major shippers, including Procter & Gamble, PepsiCo, and Apple, boast much higher gross profit multiples despite typically higher gross margins, which stems from a structurally higher level of profitability and a higher risk premium.
Moreover, the Swiss forwarder’s revenues are rising, but the rise is costly.
COGS amounted to Sfr116 a share in 2016, while the major operating cost, personnel expenses, stood at Sfr27 a share.
Until the end of September, sales rose to Sfr171 a share – a growth of Sfr9 in absolute terms from Sfr162 a share in the first nine months of 2016 – but gross profit per share fell by Sfr2.8; lower staff expenses offset only Sfr0.33 a share of that loss, and that is because there comes a point when a people business must invest in human resources if it is to thrive.
Some Sfr11.3 a share more than a year earlier was absorbed by higher costs from carriers, many of which are after more profitable volumes, so what this means is that if in 2019 Panalpina will end up paying a lower dividend, we’ll likely know that would be a case of investing in operating costs to preserve market share at a critical economic juncture.
It also must properly manage the cash pile sitting on the balance sheet. Last year it said: “The cash position remains very healthy with roughly Sfr390m at the end of 2016, which is practically unchanged from the previous year.”
(It added: “In light of the healthy net cash position and stable profitability, the board of directors will propose an increased (+7%) dividend payment of Sfr3.75 per share to the annual general meeting on May 3, 2017. This is equivalent to a dividend yield of 3% based on the 2016 year-end share price.”)
This year, Panalpina will likely book Sfr310m (Sfr13 a share, or just 8.9% of its current market value) of cash and cash equivalents, which is also its net cash position.
If the dividend was halved, say, to deploy Sfr1.87 a share (Sfr44.5m) in buybacks, it would not move the needle in terms of valuation, so the EPS boost story would work only if it launched a major buyback.
The board must deliver value by showing investors that is proactively working towards a more balanced capital structure, where a bit of debt would ideally serve the purpose of protecting the stock in the hard times, while boosting it if the good times for the freight forwarders are here to stay.
However, large buybacks could help shore up pro-forma EPS over time, boosting, in turn, dividends per share (due to a lower share count), but it would likely have an immediate dilutive effect on earnings per share, according to my calculations, probably rendering it a costly, and not very effective, experiment over the short term.
In other words, a paucity of alternatives could be a problem even for Panalpina, whose shares this week got closer to the five-year record high that is just a shade above its current level of Sfr146.