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Hong Kong-based 3PL Kerry Logistics has plenty of dry powder left for further M&A activity, following a string of bolt-on deals in recent months (see here, here and here) – but is its management team up for the challenge?
I would judge, based on recent events, that it is – but not everyone agrees.
“Kerry management cannot see the wood for the trees,” a transport and logistics banker in London harshly stated this week, while another pointed to “positive ‘catalysts’ in its careful assessment of risk and corporate strategy”.
While its corporate story divides my banking sources, there are scant signs its mission could be eventually accomplished, although it has become tougher to manage than in the past – so, I have to ask whether, and how, it could deploy precious cash reserves, or raise new debt, to exploit its sound balance sheet; and if it should do so as early as this year.
Funding & returns
A high single-digit weighted cost of capital – only marginally lower than its return on invested capital – is a rare opportunity in a market where equity risk premium, rather than funding cost, is on the rise for most freight forwarders.
In other words, Kerry could continue to fund inorganic growth at convenient rates, but profitable growth itself and rising returns are possible only if it identifies the right opportunities in the right markets while applying a proper corporate strategy, given that profits and revenues must grow more swiftly
So, is a diversification of services and a more balanced geographical mix, perhaps, part of the answer?
Its most recent deal-making in Spain and Germany came after a year during which its stock struggled to shine, to put it mildly. That said, Kerry was only mildly acquisitive and instead decided to stick to the knitting, snapping up Apex Maritime, a specialist in transpacific trades, in the first half of 2016, and freight forwarder Bofill & Arnan in December.
Now trading at multi-year lows – despite a forward dividend yield above the industry average, boosted by weakness in its share price – its stock changes hands at paltry multiples, as the table below shows.
This partly depends on sub-par returns, along with uncertainty surrounding its Asia-centric portfolio, but there might be other problems that I doubt buybacks and a higher payout could sort out. So, I am pleased to say, once again we come to possible M&A alternatives.
Although senior logistics sources in the freight forwarding industry recently told me that smaller regional players chasing market share in the UK and Europe have often “lived in the shadow of the big companies” –and in principle I agree any major takeover would likely be expensive for most suitors – Kerry should carefully gauge its options before certain targets become prohibitive in terms of equity value.
But despite its obvious appetite for acquisitions, a couple of questions need to be answered. Firstly, how much money could Kerry afford for either? And secondly, is it really ready to diversify from its core businesses in the name of a more balanced geographical mix?
It could make sense, not only currency-wise. With manageable net leverage of about 1x, Kerry could raise debt either to fund a £400m offer for Wincanton (£1.1bn 2017e revenue) or a £500m proposal for Clipper (£365m 2018e revenue), with the former being a larger profit pool and the latter representing a hugely attractive growth alternative.
On a pro-forma basis and excluding synergies, an all-cash, debt-funded deal for Wincanton – one implying a 30% equity premium – would more than double the net leverage of the combined entity to 2.2x, while a similarly funded tie-up with Clipper would push up net leverage to 3x, according to my estimates.
Typically in M&A, cost synergies amount to at least a low single-digit percentage of the target’s revenue, in which case the higher net leverage associated to both combinations could actually be more beneficial than harmful, meaning more financial efficiency under both scenarios, although consolidating Wincanton could make more sense than Clipper, given the former’s relative scale and a more attractive valuation.
Reality kicks in
From the drawing board to reality, then, and Kerry’s current strategy signals that it is carefully managing its deal pipeline and it may not pull the trigger on either. But then look at the table below from Transport Intelligence.
(Of course, if this table provides any hint as to where Kerry could grow inorganically, outsourcing specialists Clipper and Wincanton should be ruled out as plausible targets – although diversification of services could make a lot of sense in a rapidly changing market for sea freight.)
Difficult decision times, at least strategically, as CJ Korea Express, which nearly trails Kerry, has mandated Armstrong & Associates to look for targets worth about $500m in the US; its other closest rivals – Agility and CH Robinson – are also likely to entertain more deals sooner rather than later, given their stated intentions and track records; and finally, Dachser – which also chases Kerry in the sea freight rankings – is rumoured to be mulling M&A options.
Some of the largest global freight forwarders are, we understand, looking to bulk up. One rumoured predator is France’s Geodis, which might be eyeing debt-laden CEVA. Another is Denmark’s DSV, whose managers have been seeking bolt-on deals, according to sources close to the board.
And smaller companies are mopping up assets, as proved by Radiant Logistics in the US, whose ambitious corporate story – given the way its deal-making is financed, among other things — captured my attention at the end of 2015.
Yet one of the most interesting deals was recently executed by UPS – which, as we reported on 9 January, “is set to expand its footprint in the UK-Europe trucking business with the purchase of UK haulage service provider Freightex”.
That acquisition was announced only a couple of days after UK network Pallet-Track made the unusual move of buying Horley Services Group, a haulage and distribution firm based at Redhill.