There is a growing “performance divide“ in freight forwarding, based on differences in customer/product mix, IT functionality and management, which is likely to lead to a pick-up in sector M&A, according to a report by investment bank, Jefferies International.
“While the sector enjoyed the strongest volume growth in years (8% in air, 4% in sea and 3% in road freight), yields were under pressure, due to increased freight rates, which resulted in relatively sluggish EBIT growth of 5% on average in the first half of 2017,” it underlines according to Lloyds Loading List.
“There were large differences in performance, with a 31% EBIT drop for Panalpina, a 1% decrease for Kuehne+Nagel (but a 4% increase on an underlying basis) and a 54% EBIT increase for DSV, driven by the integration of UTi. We expect the growing performance divide will lead to a pick-up in sector M&A, with both DSV and XPO Logistics recently expressing an interest to further consolidate the fragmented freight forwarding sector,” the report added.
In an assessment of three major players in the sector as investment opportunities, Jefferies reiterated its 'buy' rating on DSV, “as the 'best in class' freight forwarder and leading consolidator in the sector.“
It upgraded Panalpina to 'hold,' “as an increasingly likely takeover target,“ and downgraded Kuehne+Nagel to 'underperform,' “as it's at peak performance.“
DSV had “the strongest growth track record and the highest and least volatile profit margins,” it added.
“We have further increased EPS (earnings per share) estimates by 4%-8% and our DCF (discounted cash flow)-based price target to DKK 500, reflecting better than expected profitability in air & sea. DSV indicated it will resume its acquisition strategy, with an appetite for relatively larger targets in excess of $1.0 biilion. We think this would be an important catalyst for the stock, given management's strong acquisition track record.”
Turning to Kuehne+Nagel, Jefferies said the Swiss-based group was “at peak performance,” as it has met its 5% EBIT margin target since 2015, despite still relatively low profitability levels in Overland and Contract Logistics.
“We have increased EPS estimates by 2%-4%, reflecting the acquisitions in perishables air freight logistics. We downgrade our rating to underperform with a CHF 140 price target, as Kuehne+Nagel has become the most expensive freight forwarder, at a 12% premium to the sector, while it is at peak operational performance.”
As for Panalpina, Jefferies said ITN had suffered the most from higher freight rates and a restructuring-driven earnings recovery has so far failed to materialise, with the operating performance further deteriorating after the strategy update by the new CEO in September 2016.
“We have cut FY17E EPS by a further 24%, now assuming a 12% drop in FY17E EBIT, as a yield recovery is looking less likely. We upgrade our rating to hold with a CHF 110 price target, as Panalpina has become an increasingly likely takeover target in our view, with sector M&A expected to pick up.”
The report concluded by highlighting the valuation of freight forwarding firms and the risk factors they are exposed to.
It said the sector was trading “at 11.9x FY18E lease-adjusted EV/EBIT. DSV and Panalpina are trading in line with the sector, while Kuehne+Nagel trades at a 12% premium and Deutsche Post DHL at a 16% discount.”
Risk factors include macro-economic risks, impacting freight markets, rate volatility, the ability to maintain competitive IT systems and increasing competition from suppliers.
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