News / Analysis: Q2 results provide Maersk some relief, but any celebrations may be muted

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There must be a sense of relief in the Maersk boardroom following its second-quarter results last week – although it may be too soon to crack open any champagne.

The equity value of the Danish shipping conglomerate has risen 5% – or more than $2bn – since last week, placing its stock performance in positive territory year-to-date: a 0.8% increase based on Friday’s close.

Maersk is the world’s largest container shipping line, the second-largest port operator and the seventh-largest freight forwarder – all of which is valued at paltry trading multiples of nine times based on its forward net earnings into 2017.

If that’s low, consider that its Enterprise Value/Ebitda ratio is forecast at 4-5 times over the next couple of years.

In share-price terms this means that Maersk stock is dirt-cheap, and suffers from a conglomerate discount that its current strategy – focused on non-core divestments – will attempt to address.

These valuation metrics become particularly appealing after taking into account the group’s reiteration that its strategy is “targeting profitable growth through business optimisation, cost reduction and a strong customer focus to maintain top-quartile performance with a ROIC [return on invested capital] above 10% over the cycle in all business units”.

And there are other elements that suggest that Maersk could be a bargain.

Its shares currently change hands some 12% below consensus estimates, according to Thomason Reuters, but if a bull-case scenario plays out, the upside could be up to 40% for shareholders, according to some analysts.

Estimates have dropped by about 40% since their highs of October 2014, but Maersk could surprise investors and analysts now – its stock, which trades around the Dkr12,500 (US$1,855) level, is not far off its support line for the year, and is about 20% below the 52-week, all-time high that it hit in mid-March.

A technical analyst could easily argue in favour of an inflection point, suggesting hefty capital gains as the most obvious outcome for shareholders. According to this methodology, Maersk stock could surge at a fast pace, breaking through its previous record rather than falling rapidly – a view that is also backed by a decent set of interim results and a revised, more upbeat, guidance for the year.

However, I think that its capital allocation strategy is strongly focused on short-term value rather than the long-term interests of all stakeholders. Hence, its strategy may not pay off.

Results

At group level, revenues were down 10% to $21bn in the first-half of 2015, while Ebitda fell 15% to $5.2bn. ROIC dropped to 10.2% in the second quarter, down from 18.6% in 2014. This contributed to a half-year ROIC of 12%, down from 14.3%, on a comparable basis.

Other metrics, such as return on equity, have similarly deteriorated. Elsewhere, earnings per share halved in the second quarter, and although core cash flows per share held up, that was only mildly encouraging.

Maersk seemed upbeat about its latest achievement, but I am not sure executives are aware of the risks surrounding their current corporate strategy based on the group’s fundamentals. They appear to be betting on Maersk Line, where some 42% of total capital invested in the operations is being allocated – that’s about $20bn for the unit.

The group adjusted its annual return target for the division “from 8.5% ROIC to between 8.5% and 12%”, it said last week, which helped boost Maersk’s stock price, along with the announcement of a stock buyback of 1bn.

But why has Maersk decided to invest $1bn of capital to buy back its own stock, while focusing on a core division that promises little growth?

One possible answer is that Maersk has no other choice. In support of this, look at where the group is saving precious dollars to return cash to shareholders despite a muted core cash flow profile.

Logistics arm Damco is slimming down – just $286m was invested in it in the first half of 2015, compared with $514m in the first half of 2014 – but the division made a made a profit of $7m, against a loss of $32m in 2014.

Damco reported a -25.8% ROIC last year, but 2015 figures point to a business that is in recovery mode – and one with an ROIC of 8.9%.

Although revenues declined 17% to $655m, with “approximately half of the drop caused by rate of exchange movements… volumes grew by 8% in the supply chain management product”, the group said, adding that the restructuring efforts carried out in 2014 had driven productivity improvements and reduced overhead cost.

Damco is part of APM Shipping Services, which also includes Maersk Supply Service (amount of invested capital $1.7bn); Maersk Tankers ($1.6bn); and Svitzer ($1.1bn).

The amount of invested capital cuts in these four units amount to about $800m year-on-year, and is very similar in size to Maersk’s $1bn stock buybacks.

This could mean two things:

• Maersk will discontinue/sell one or more of these four units as soon as their respective turnarounds are completed, because it does not intend to pour money into them;
• Maersk is not investing enough in smaller businesses, focusing instead on its core units (“Line” investment is up $170m, “Oil” investment is up $950m, “Drilling” investment is up $1.5bn), with only APM Terminals down by almost $400m year-on-year in terms of invested capital.

Why would any buyer pay top dollar for units that will likely need greater investment over time it remains a mystery to me. Hence, if I am right, Maersk will likely continue to suffer from a conglomerate discount for a very long time.