ANALYSIS – Shareholder pain at UTi Worldwide as its financial strength ebbs

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While the attention of everybody in the logistics industry this week concerns which way shareholder value will go if XPO Logistics manages to complete its $3bn purchase of Con-way, a chronic underperformer across the Atlantic has also caught our attention – 3PL UTi Worldwide.

In fact, there’s every chance UTi will attract interest from suitors after its third-quarter results are announced in early December. We were right with Con-way, predicting a 30% takeover premium back in May, so let’s see how this one plays out.

Of course, Denmark’s DSV is in the driving seat to acquire the ailing US-based freight forwarder.

After UTi reported its quarterly update earlier this month, its shares plunged 10.4% and have not recouped much of their value. They currently change hands at $6, which implies a market cap of just $644m and a price-to-book value above 1.7 times – both of which suggest more shareholder pain is likely.

Its ocean and airfreight forwarding business is troubled and losses are mounting, while trust has gone out of the window after a downbeat Ebitda guidance was released by management. Estimates appeared to be too bullish, as we argued at the end of last year, and there are other problems.

As quarters go by, its cash flow profile is not getting much better, once certain items are excluded, and its capital structure is clearly problematic.

Now, consider this: during the three months ended July 31, UTi recorded a charge of $50m for goodwill impairment. The group “is currently in the process of finalising several of the key assumptions used in its annual goodwill impairment test and anticipates completing the process in the third quarter”, it said in its results presentation.

“Changes in business strategy, government regulations, or economic or market conditions have resulted and may result in further substantial impairment write-downs of our intangible or other assets at any time in the future. In addition, we have been and may be required in the future to recognise increased depreciation and amortisation charges if we determine that the useful lives of our property, plant and equipment are shorter than we originally estimated.”

Much of that is standard corporate jargon, however the timeline for goodwill impairment testing is pretty tight, and we should expect news on whether the value of other assets is out of whack with reality by the end of the year. Until then, it’s highly unlikely that any buyer will show up if there is any risk of some nasty surprises in its accounts.

Cash flow

Goodwill charges show on the profit and loss statement, but they are non-cash items, so they must be added to the net losses of UTi in order to determine its operating cash flow.

Net losses in the first-half of the year stood at $104m ($65m of net losses were recorded in the first half of 2014), but once all the proper adjustments are made to determine UTi’s core cash flows, that comes in at a $7m in loss the first half of 2015 compared with a $125m loss the same period the year before.

So, its cash flow line is up year-on-year, but it would be further in the red if UTi had not been so assiduous in collecting from creditors. In fact, its operating cash flow would be minus $64m if account receivables of $57m (-$95m in 2014) were not considered.

It would be great if management told us what kind of level of receivables they see as critical going forward because then we could discover that the speed at which UTi collects its short-term credits is slowing down significantly, which is a distinct possibility, and its short-term liquidity profile might become unsustainable.

It has cut back on capex, but around $30m of interest costs must be paid every six months, and it has only $200m in the bank. UTi is walking a tightrope, with a net increase in cash and cash equivalents of only $3m in the first half – the current liability side of its balance sheet leaves little room for error, too. Finally, currency swings are not playing in its favour.

Hence, additional downward pressure on its stock price is very likely, unless a bigger rival comes to the rescue. Its shares are down 50% since the turn of the year, and they have fallen 8% since last week.

Talking of top fallers in the market, mention must be made of XPO Logistics, whose stock lost 11% of value in a day after investors failed to digest another multi-billion deal that pushes up net leverage of XPO into dangerous territory. Are the bears right, though?

Well, cost synergies of just 1% as a percentage of Con-way’s $5.5bn projected sales would bring in additional earnings of $60m, while the deal is accretive to XPO’s core operating margins and earnings. It should be doable – XPO forecasts up to $210m in cost savings, or about 4% of the target’s forward revenues.

However, it was only at the end of April that XPO announced the $3.5bn acquisition of Norbert Dentressangle, one of Europe’s largest privately owned haulage and logistics groups. In early June, I wrote that the US group is “a textbook example of a freight brokerage firm pursuing growth – sustainable growth – that allows it to take calculated risks.”

Such an aggressive M&A strategy brings heightened integration and execution risks, which could preoccupy investors more than any possible upside associated to stronger growth and earnings prospects.