Stockwatch: A high-quality Woodford holding

Is Eddie Stobart Logistics (ESL), the AIM-listed spin-off from Stobart Group (STOB), poised to sustain the strong progress and share price performance of its parent?

ESL floated in April, raising £130 million to cut debt and finance development: initially the £45 million acquisition of iForce Group, an e-commerce logistics group, then in July a 50% stake in Speedy Freight, which proclaims to be “the UK’s No.1 courier and same day delivery service”, also a remaining 50% stake in The Logistics People.

As yet, the stock has flat-lined in a 158p to 164p range, currently 160p with latest interims to end-May seemingly lacking fresh stimulus. So, what’s behind Woodford Investment Management taking a 19.3% stake at flotation, worth over £110 million currently?

4% supportive yield while e-commerce work evolves

The crux investment case is a very soundly based, respected business in Eddie Stobart road haulage, and improved cash flow profile, thus expectations for about half of earnings paid out as dividends – for a prospective yield close to 4%.

As yet, the prospects in e-commerce logistics appear loss-making, thus a prospective price/earnings (PE) ratio of about 13 rather caps the share price for now. But, as the acquisitions get integrated and synergies kick in, there looks scope for this side to turn up smartly in the longer run.

Mind that, unless there’s a new year trading statement, the real insight may not be until 2017 prelims, as e-commerce activity tends to be second-half weighted, given the importance of Christmas.

As we’ve already seen by way of Tritax Big Box (BBOX), growth in demand for e-commerce logistics may mean a stock looks fairly priced but can still deliver long-term capital growth. They ought also to mitigate the risk of economic downturn affecting road haulage services, and how Brexit plays out. Eddie Stobart derives some 93% of revenue from the UK and 7% from continental Europe. The elements being assembled look promising.

Double-digit underlying financial growth

First and latest interims to end-May show 14% growth in underlying operating profit to £16.9 million on underlying revenue up 13% to £287 million, in line with expectations. Exceptional items (mainly refinancing and flotation) of £12.6 million means a £6.3 million statutory pre-tax loss, otherwise management proclaims “underlying growth in all key businesses”.

A 56% conversion of operating profit to cash supported free cash flow of £11.1 million, a radical turnaround from £3.4 million negative, like-for-like, which augurs well for continued debt reduction (net debt of £97.7 million versus £186.8 million) besides dividend growth.

Key objectives are to invest in growth businesses and sustain margin discipline. A sponsored research note from Edison has resulted in slight upgrades (mainly reflecting acquisitions and incorporated in consensus figures), which would likely have been signed off by the company thus approximate to budget.

Essentials of corporate development are therefore coming together for the risk/reward profile to favour upside. Edison targets 203p per share, according to economic value added and discounted cash flow valuation.

Re-balancing road transport towards e-commerce

Road transport accounts for £199 million, or 70% of interim group revenue, and £18.7 million, or 94% of operating profit – growing at 4% and 15% respectively.

A “sector served” than functional approach is more helpful to understanding group dynamics, though mind discontinued businesses distort the revenue breakdown provided.

For example, e-commerce is up 51% underlying and 42% to £36.9 million on a reported basis, which is encouraging given only one month’s contribution from iForce, and retail is up 10% than down 5% to £80 million. The “manufacturing, industrial & bulk” sector is also doing well, up 22% to £80.9 million.

Margin information is yet to be provided on a sector basis, and a first-half underlying operating margin of 4.1% appears down according to the Company REFS table. But, from the actual results, it is consistent with H1 2016 when the full-year rose to 5.3%. With peak e-commerce demand towards Christmas this is likely to make the group even more second-half weighted.

A significant influence will be synergies arising from iForce, if hard to say exactly when. Management proclaims “a strong rolling pipeline of potential new business weighted towards e-commerce, manufacturing and industrial & bulk”. New contract wins totalled £25 million during the first half. So, it’s hard to see the group compromised by a need to warn in the short to medium term.

Reduced debt service costs should also help

The income statement shows pre-exceptional finance expenses of £6.9 million shearing a hefty 59% of underlying profit, and not to be confused with a further £6.6 million exceptional finance charges. Nearly halving net debt should therefore provide another enhancement to figures, helping justify the profits/earnings re-rating.

Be aware, though, acquisitive development will mean an ongoing split between statutory numbers and those before amortisation of acquired intangibles; the £5 million charge being fairly consistent but which looks set to rise given recent acquisitions made.

UK consumer/business cycle is chief risk

Management appears to be implementing a valid strategy well; the chief executive owning 875,000 shares and the finance director 313,000 shares thus aligning interests with outside investors. Long-term investors will be aware, however, there’s likely a sense among investors, distribution services are ultimately cyclical, thus “wait and see” for more evidence.

The bear case is the UK economy inevitably turning down due to Brexit and unsustainable consumer credit, with logistics suffering to an extent that cancels out the benefits from e-commerce growth.

A 4% dividend yield barely offering compensation for this worse-case scenario, dividend growth could be checked and the stock ease to price for a yield that does tempt buyers.

But this is the rump of the original Eddie Stobart haulage business that has been a successful enterprise since the 1970s, weathering recessions. There is little sign of downturn as yet, and the rebalancing to e-commerce should be well-integrated by the time it happens. The bear case is indeed a scenario, albeit less likely.

This is not a stock to excite traders, yet is attractive as a long-term investment for income and capital growth, based on a quality business – as Woodford implicitly believes.

Eddie Stobart Logistics – financial summary Consensus estimates year ended 31 Dec 2014 2015 2016 2017 2018 Turnover (£ million) 347 496 570 IFRS3 pre-tax profit (£m) 6.6 6.1 11.2 Normalised pre-tax profit (£m) 6.6 8.1 13.1 41.3 51.9 Operating margin (%) 4.5 4.6 4.7 IFRS3 earnings/share (p) 1.3 1.3 2.8 Normalised earnings/share (p) 1.3 1.5 3.3 11.0 12.7 Earnings per share growth (%)   14.0 127 229 15.8 Price/earnings multiple (x)     48.0 14.6 12.6 Cash flow/share (p) 8.5 7.7 4.9 Dividend per share (p)       5.7 6.5 Dividend yield (%)       3.5 4.0 Covered by earnings (x)       1.9 2.0 Source: Company REFS

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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