No break up for Wincanton with profits on the rise, says CEO
Wincanton chief executive Adrian Coleman has poured cold water on breaking up the group as ...
Rather unexpectedly, I have found myself considering the provocative idea of a merger or some sort of corporate activity leading to deeper ties between Kuehne + Nagel (Sfr18bn market cap) and Panalpina (Sfr3bn).
Of course, the aim of a combined entity – on paper, this is the less likely option A – would be to create stronger dividend machine and a more predictable income growth story for their investors, who can hardly be pleased with the way things have gone in the recent past.
Label them unlikely suitors, but there are striking similarities between the two — not least financially at this particular point in time — that underpin the idea of a merger.
Then, option B: engineering a way to combine their ocean freight activities could be a smart move indeed.
In its current form, market leader K+N is easily one of my least favourite names in freight forwarding, lagging even Panalpina in my personal rankings for asset-light T&L businesses that I believe remain grossly overvalued on the stock markets, even after their latest share price plunge.
Despite the headlines pointing to a flying start in the first quarter, K+N is exposed to shaky sea freight rates and volume prospects given global recession risk, among other things. The ocean business represents 30% of its total net revenues, weighing more than any other segment on total shareholder return.
Net group turnover, up 13.1% to Sfr4.8bn in the first quarter, grew once again at a steeper pace than gross profit (up 11.8%), due to a 15.4% rise in costs for services from third parties. K+N is good at managing operating cost inflation, pushing up both Ebitda (to Sfr236m) and Ebit, and despite higher income tax expenses, quarterly earnings rose 11.5% to Sfr184m.
However, this is a great earnings story that completely overlooks how its cash balances are changing, and its ability to be more productive in terms of free cash flow is another key element as its stock price tries to bounce back from recent lows.
Against the end of March 2017, its first-quarter cash and equivalents were down 15% to Sfr717m, despite higher operating cash flows (OCF) at Sfr33m versus –Sfr22m in the first quarter of 2017.
This Sfr55m rise in OCF was almost fully offset by surging cash outflows from investing (-Sfr52m).
Its balance sheet is rock-solid, but K+N’s free cash flow (FCF) yield was barely positive in the first quarter. Blame seasonality for that, but then look at trailing annual trends for FCF (OCF minus capex) and compare them to the payout.
It churned out about half a billion in 2017 (Sfr780m – Sfr245m = Sfr535m), down significantly versus the prior year (Sfr848m – Sfr174m = Sfr674m). It was also weaker than 2015 (Sfr1,010m – Sfr421m = Sfr589m) and 2014 (Sfr810m – Sfr156m = Sfr654m) numbers.
In the past four years, the dividend it paid out was Sfr658m (2017), Sfr599m (2016), Sfr839m (2015) and Sfr701m (2014).
We might have reached a turning point, although its minor deal-making could render upcoming numbers, and cash outflows, less painful in the second half.
Essentially, K+N burned more than its free cash flow (Sfr2.45bn on aggregate vs dividends of almost Sfr2.8bn since 2014) and should have allowed it to pay dividends over a four-year period during which an inflation-beating yield has only mildly contributed to shore up its share price – which, at the end of 2014, was Sfr137 vs Sfr155 currently.
The boost its stock received in 2016 and 2017 was cyclical, rather than driven by focused/transformational corporate action.
If you are familiar with Panalpina, you’ll know its shareholding structure – as with K+N, which remains controlled by the Kuehne family, Panalpina is controlled by the Ernst Goehner Foundation – dictates corporate strategy and the payout is similarly stretched, based on earnings and free cash flow metrics, while the ocean freight business is navigating the same choppy waters.
Its latest results confirmed its payout could become a bit more problematic, given headline coverage metrics, but it remains a top priority for management.
Net operating cash flow fell in the first quarter on a like-for-like basis, when it maintained Sfr304m of cash on the balance sheet.
When compared to K+N’s balance sheet, its finances are similarly sound but gross cash is about 30% lower on a comparable quarterly basis (Sfr399m on 31 March 2017), and stable quarter on quarter. Yet last year’s dividends rose, because Panalpina could easily afford it, given its gross cash position.
What am I getting at?
Well, K+N’s 1x gross cash/payout ratio compares with Panalpina’s over 3x, and if the former were to buy its smaller rival it could access that cash pile, right?
Freight forwarding leader K+N is the epitome of a company at the mercy of market forces because paying a hefty dividend to its owners is a must, despite market positioning, know-how, portfolio cyclicality and investment in key strategic areas that should all make it a star performer on the stock market, particularly in terms of capital appreciation and given air trends, where it is the unchallenged world leader.
So, could K+N be opportunistic and approach informal conversations with the one and only possible partner, really, who could understand the needs of its shareholders if a merger occurs?
In other words, could it pay a premium and access the cash pile of Panalpina and boost the dividends prospects of a combined entity and, in turn, its own?
I wasn’t kind when I highlighted remarks that its management team shared on M&A, and once more I find myself sceptical of its outlook unless some serious action takes place. It seems to me that is Sfr700m in annual dividends is a waste at a time when all the major freight forwarders need to explore new alliances, exploit different trends and clients’ needs driven by changing consumer habits, which means it ought to be ready to splash out top dollar.
How about K+N’s joint ventures, for example?
Well, despite some eye-catching headlines, investments in joint ventures was booked as an asset worth only Sfr8m at the end of Q1; while annualised figures are higher, size-wise they are pretty negligible.
The most obvious way to inflate earnings per share would be to lever up using debt to repurchase stock, while perhaps cutting the dividend by half and becoming a less boring income stock, but the rise in transport costs could be better managed if it looked for new synergies.
Aside from stellar growth rates in air, the dividend is all that both K+N and Panalpina have to offer in their current forms. And in these situations – where companies have relatively small free floats and the owners control the business directly and also dictate corporate strategy – value creation is often an uphill struggle.
But a bigger, unified Swiss behemoth would be a great outcome, I reckon.
The problem with a merger under scenario A is that given their relative valuations, an all-equity deal or a deal financed under almost any other scenarios, would likely be highly dilutive for the owners of Panapina, who might eventually retain a significant stake but not large enough to influence the board.
Trends are visible across the industry: air businesses are growing fast, and that value is likely trapped as ocean trades are only barely holding up in terms of profitability (versus growth), while other ancillary logistics businesses have tended to become less ancillary, although they could dilute returns.
So why not think of a K+N/Panalpina tie-up in ocean, spinning off only those activities and retaining full control via a holding company of a separate, listed unit, possibly under a “PAN K+N” umbrella? Essentially, the two Swiss companies would control the same operations under two or more different corporate umbrellas, but they could test their relationship.
The Panalpina brand itself could gain in intangible value (this, typically, means pricing power) and there could be cross-selling opportunities elsewhere (procurement, logistics). K+N, which would likely get a better deal in sheer economic terms, could help Panalpina fix its problems in the ocean trade.
Without ocean activities on their books, the remaining rumps of the two forwarders could enjoy the full upside that air freight growth brings these days, with air “assets” (contracts) and M&A strategy in air likely turning out to be much more relevant for investors – which could even open the door to a future merger of their air operations, if things go according to plan in ocean. Their growth strategy in perishables is similar, by the way, so it could be an easy story to sell.
Strategically, the “weaker” spun-off ocean freight business – still representing the largest sea freight forwarding operator in the world would be triple that its closest competitor, DP-DHL, based on trailing sea freight revenues numbers – could also develop a mission aimed at exploiting deeper ties with carriers, in what could be another twist after CMA CGM recently took a near-25% stake in CEVA Logistics. That deal reinforced the view that consolidation is currently one way only from the carrier to the forwarder – or did it?
I will touch upon this in my upcoming CMA CGM analysis later this week.