Panalpina must invest top dollar in reshuffle - but has cash to spare

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“Dear Shareholders, this past year was decisive for Panalpina: in 2014, we delivered solid results and more than doubled our overall profitability. The strategic priorities set in 2013 are delivering the right results. In a challenging market environment, the company achieved an Ebit of CHF116.7m ($120.5m) and a consolidated profit of CHF86.5m.”

So began Panalpina’s annual result statement on Wednesday, which essentially showed the group is still in restructuring mode. What did it also bring?

Air freight volumes grew 4% in 2014, broadly in line with market trends. The Swiss forwarder transported 857,800 tonnes of air cargo, with gross profit per tonne down 3% to CHF742 year-on-year. Volumes in ocean freight, meanwhile, rose 7%, outperforming the market.

“Due to continued business wins in high-volume but lower-margin business, gross profit per teu of ocean freight decreased 7% to CHF306,” the Swiss forwarder noted.

Finally, gross profit for the ailing logistics unit surged 5% to CHF458.2m.

“Panalpina further expanded its Logistics Manufacturing Services (LMS) and other Value-Added Services (VAS), particularly for the technology and fashion industries,” Panalpina said, adding that by parting with a number of loss-making facilities and unprofitable road activities, the division “drastically reduced its Ebit loss well ahead of schedule to CHF8.2m in 2014, down from a loss of CHF49.9m in the previous year.”

Value

There are two different ways to deliver shareholder value at Panalpina – and neither is going to be easy to carry out, in our view.

Managers could state their intention to engineer a break-up of the Swiss forwarder by separating its three core units – air freight, ocean freight and logistics – in order to render each division more palatable for trade buyers.

The outcome? Anything could happen, really, but could Atlas Air show interest in the air freight unit? It’s less obvious who may dare to target the reminder of Panalpina’s asset portfolio. (Needless to say perhaps, partnerships are the way forward.)

Alternatively, management could team up with a financial sponsor and exploit the company’s overcapitalised balance sheet, raise a modest amount of debt and take it private. On the face of it, there is little benefit, if any, in keeping Panalpina shares listed on the public market.

In its annual report, Panalpina highlighted trends for its share price since the end of 2010. Indeed, the shares have more than doubled to CHF149.5 at the end of 2014 from CHF64.4 at the end of 2010.

Do not hold your breath. In truth, Panalpina has never fully recovered from the credit crisis, with its stock down 50% from the record high (CHF259) it recorded in June 2007- a zenith it reached only a couple of years after its shares were floated.

Core profitability

2014 revenues and gross profit were flat year-on-year, but Ebit rose to CHF117m from CHF48m, annual results showed. It is tempting to suggest that operating results were truly impressive, in spite of very challenging market conditions.

The group “continued to deliver stronger results with improved overall profitability and operating margins, despite uncertainties in the global economy,” Panalpina noted.

“An increased focus on improving productivity and stabilizing performance translated into a substantial improvement in Ebit, which highlights the headway Panalpina made in executing its strategy and its ability to improve performance and streamline operations.”

The problem is that heavy investment is also flat year-on-year, while its cost base and D&A (depreciation and amortisation) are virtually unchanged. So, how could Panalpina manage to more than double its core level of profitability?

Enter “fines” and “goodwill impairment”. The former stood at CHF40m in 2013, while the latter came in at CHF19m – both, of course, negatively contributed to the bottom-line in 2013.

Ebit, or operating income, is “a key performance indicator for assessing the group’s operating performance”. Operating income more than doubled in 2014, but if you add back the combined CHF59m for fines and goodwill impairments to 2013 Ebit of CHF48m, then Ebit comes in at CHF107m.

(Incidentally, 2014 net profit was up CHF65m for the year, i.e. only CHF6m more than the combined value of fines and impairments.)

So, Panalpina generated only CHF10m of additional core operating income on a yearly basis. Once other P&L items under the Ebit line such as finance costs – down by about CHF11.5m – and income tax expenses are considered, it appears clear that Panalpina’s net income has improved by only about CHF2m, on a comparable pro-forma basis. The shares were hammered on Wednesday, but some investors are buying on weakness today: they ought to be very careful. In this environment, additional one-off charges may weigh on core profits well into 2016.

Good stuff

“Panalpina’s business year and the performance of the share were shaped by the uncertainties in the global economy,” the group said in its annual report, and that shows in its financials as well as in a stock price that dropped 10.7% last year, having underperformed the Swiss Performance Index by almost 23 percentage points.

What is good, however, is that net cash was up to CHF371m from CHF339m in 2013. While working capital management is improving, with CHF55m of cash inflow from receivables – which compares with receivables outflow of CHF121m in 2013 – working capital changes only marginally (CHF25m) contributed to a rise in net cash from operating activities, up to CHF123m from CHF42m in 2013.

Free cash flow at CHF87m implies a yield of 2.8%, which admittedly is a dramatic improvement since 2013, when Panalpina reported negative free cash flow (-CHF5m), but also signals that it would be a great time now to entertain either a management buyout or a break-up of the group. But then, shareholders may want to consider more accurate metrics to gauge management performance.