ANALYSIS: Kuehne + Nagel – a solid performance, but still disappointing shareholders

Swiss 3PL Kuehne+Nagel (KN) sent a strong signal to the transport industry last week as it reported its unaudited financial results for the quarter ended 31 March.

On the one hand, it showed what kind of factors are behind a solid performance in a difficult market, and on the other I believe it continues to remain a rather disappointing story for stock investors and existing shareholders.

Market momentum

Air freight was more resilient than sea freight, although both suffered. Management shrugged off concerns related to fast-falling revenues in both units, and instead referred to “positive momentum carried into 2016”.

It said “in the first three months of the year, the KN group continued the positive development of the last two quarters of 2015”, adding that while net turnover “slightly” declined, gross profit increased by 6.4% to almost SFr1.6bn, which was one of the most impressive financial figures.

The extremely challenging sea and air freight market didn’t affect financials at group level, due to the solid performances of the smaller overland and contract logistics units, whose combined revenues amount to 40% of group total.

Investors welcomed the news on 18 April, but a sustained rally from its current level of SFr140 a share must be supported by some serious corporate action, in my view, and the bounce in its valuation earlier this week was, unsurprisingly, short-lived.

KN says it is not exposed to “significant” seasonal or cyclical swings, and that could be partly explained by its attempt to retain more profitable clients over time, but sea freight still represents almost 35% of its net turnover before the elimination of inter-segment sales, and is down 8% year-on-year.

Add to that a 7.3% drop in air freight net revenues, and some 60% of its total assets are churning out higher cash flows and earnings only because it is using its scale to negotiate highly competitive rates from its carriers – net expenses for the two core units dropped by 10% on an aggregate basis.

That is reflected in quarterly results at group level, where net revenues – which exclude declining customs duties and taxes – fell 2.1% to SFr4bn, but were offset by a 7% plunge in net expenses from third-party services, which determined a significant rise in gross profit, Ebit and Ebitda, as well as in its underlying profitability.

Rising group margins – its Ebit margin was up some 80 basis points year-on-year – means that KN can easily afford to book rising expenses from staff and new investment at a time when its strong balance sheet continues to grant it plenty of flexibility with regard to extraordinary corporate activity such as deal-making.

This is not say, however, that KN intends to grab the opportunity – yet more bad news for shareholders.

Deals

In February, it acquired the outstanding 30% shares in Italy’s Nacora for SFr600,000, a company in which it already owned the remainder of the shares, and the completion of this acquisition was too small to move the needle at group level.

KN has entertained cautious capital deployment strategies over time, which could be attributed to its shareholding structure, where Kuehne Holding AG controls the majority of its outstanding shares.

In early March, it announced that Karl Gernandt would “be appointed president of Kuehne Holding AG and Joerg Wolle was proposed chairman of the board of directors of K+N International”, but neither move is likely to lead to a more aggressive corporate strategy.

However, with almost SFr1bn of cash on the balance sheet and no debt whatsoever, it has strategic decisions to take – all that cash in the bank is earning very little in a prolonged low-interest rate environment; it is an overly capitalised balance sheet, which is actually highly inefficient presently.

Another key factor is that its stock price has gone nowhere for almost five years now. One year ago, I explained that its stock was more likely to fall than to rise unless more aggressive corporate action had been considered, and that includes acquisitions.

I have to reiterate that view today.

In this context, its main operating costs – staff and SG&A – are on the rise, but after lower services costs, it delivered a double-digit growth rate in adjusted operating cash flow, which hit €259m in the first quarter.

As a result, earnings per share (EPS) surged 10.2% to SFr1.4, which indicates that EPS will likely come in at around SFr5.6-6 for the full year, yielding a forward price-to earnings ratio of between 23.5x and 25x.

That is a rich trading range, but then KN is well capitalised and offers a forward yield that is over 200 basis points above risk-free rates – both elements somehow continue to support a valuation that is close to its 52-week high.

But it might not be for long if the general economic volatility returns.