This column is written by @j_chou.
Jay has an interest in global macro trends, financial markets and equity research and enjoys applying a combination of the three in his investments. His eventual investing goal is to manage a risk parity portfolio and achieve true financial freedom.
Singapore Post Limited is the national postal service provider in Singapore. Besides providing domestic and international postal and courier services, the company also offers end-to-end e-commerce logistics solutions.
-Decline in 4Q17 logistics revenue
Logistics revenue of S$154.7m in 4Q17 was down 7% quarter to quarter after enjoying continued growth seen in previous quarters. Operating margin in the logistics segment decreased from 6.2% in FY16 to 3.7% in FY17. This could be likely due to Quantium Holdings and Famous Holdings being affected by depressed freight rates and volumes across the freight forwarding industry.
-Strong topline growth in ecommerce segment at the expense of operating losses
SP eCommerce experienced positive revenue growth across segments, especially in the eCommerce segment where it experienced 171% increase year on year. The growth could be attributed to opening of ecommerce logistics hub with clients such as Adidas and Zalora and acquisition of US subsidiary Jagged Peak and TradeGlobal. Jagged Peak saw good growth in revenue and operating profit, exceeding targets for the year and winning several new major customers. However, whilst Jagged Peak and SP eCommerce performed well, TradeGlobal’s underperformance led the eCommerce division into a net operating loss of S$33.8 million.
-Impairment of TradeGlobal
The principal issue is that TradeGlobal has significantly underperformed the business case which supported the investment. Instead of a projected profit of S$9.4 million for FY17, TradeGlobal incurred a significant loss of S$25.8 million.
Management has reported that it was due to a labour shortage in Cincinnati increased operating costs, which were impacted as well by delays in warehouse automation that were meant to improve productivity. The operational challenges also saw delays in the rollout of services for new customers. Management foresee continuing period of difficulty for the subsidiary.
-Change in dividend payout structure
Management has decided to revise dividend policy from a stable dividend payment to one based on a payout ratio of 60-80% of earnings paid quarterly due to ongoing investments in ecommerce and other growth projects.
-Strategic partnership with Alibaba
Alibaba acquired a 34% stake in Quantium Solutions International, a subsidiary, for S$86.2m in October 2016. The company also issued 107.55m new shares to Alibaba, increasing Alibaba’s holding in SPOST to 14.41% for S$187m. Under this strategic partnership, Quantium Solutions International will act as the platform for collaboration between the two companies, which would improve efficiency and integration in the e-commerce logistics industry.
Furthermore, the partnership has also assisted the postal segment as the company has seen increased transhipment volumes. As Alibaba continues to expand globally and in Southeast Asia at an accelerated rate, SingPost can look to benefit from this partnership.
-Southeast Asia’s first E-commerce integrated logistics hub
The e-commerce logistics hub has seen increasing utilisation for both its warehouse space and parcels sorting machine. With investment phase of the hub mostly done, the increase in volume will drive earnings growth. For instance, in May 17 the company announced that it is working with Lazada, Southeast Asia’s largest ecommerce platform and a subsidiary of Alibaba who has committed to move its entire warehouse operations to the logistics hub.
-Commencement of Singpost Centre Retail Mall in 2H17
The new retail mall within the SingPost Centre will have a Gross Floor Area of around 25,000 square metres, which is about double that of the former mall before renovation works commenced. Tenants of the new mall include NTUC FairPrice, Golden Village, Kopitiam and many other leading retail brands. The company has also signed an agreement with CapitaMall Asia to manage the mall.
Data from Capital IQ Database
SingPost has seen minimal growth in Postal and Logistics segment, eCommerce segment has improved by 171%, which was largely contributed by the newly acquired US subsidiaries.
Data from Capital IQ Database
However, growth in revenue has not translated into profits. In fact, net profit attributable to shareholders decreased 86.6 per cent from FY16 to S$33.4 million. Even excluding one-off charges, underlying net profit declined 24.7 per cent, reflecting the impact of planned investments, associates which are investing for growth, higher losses in the US eCommerce business and a decline in Postal operating profit.
Data from SingPost FY17 Annual Report
SingPost has consistently generated positive operating cash flows. Net cash from operating activities rose to S$200.1 million from S$131.4 million the previous year, boosted by positive working capital movements. High capital expenditure in FY16 and FY17 has affected free cash flow, but with the completion of the retail mall in 2H17 and eCommerce logistics hub the company should return to consistent free cash flow generation from FY18 onwards.
Balance sheet of SingPost is also relatively healthy, with cash and cash equivalents at S$366.6 million with total debt of S$364 million, resulting in a net cash position.
As communicated by the management in FY17 annual report: “Given the structural decline of our domestic letter mail business, it is vital we advance our transformation into an eCommerce logistics enabler, leveraging on our strategic location and core assets to serve the region’s growing eCommerce markets”
Traditional post is a dying industry; hence it is clear SingPost has shifted its focus onto restructuring its business model from traditional courier to ecommerce logistics player. Hence, expect a transitional period of 2-3 years as management prioritises expansion and aggressive topline growth over profits. The short to mid-term period will definitely pose a significant challenge given the competitiveness of the fast-growing ecommerce industry, however given the company’s economies of scale and strategic partnership with Alibaba, reaching its goal of becoming Southeast Asia’s premier ecommerce logistics provider should prove achievable.
Prospect of falling dividends also poses a big issue as SingPost is traditionally seen as a dividend play for local investors, hence the new inconsistent dividend scheme will likely scare off these investors and have a negative effect on the stock.
Lastly another point to note is the recent change of management which coincided with the shift in direction of the business model. This creates an inherent business risk and it remains to be seen if the new CEO is the right fit to steer SingPost towards eCommerce growth.
Overall, lack of positive catalysts and expected decline in profits from management represents a limited upside and signals that the stock will likely stagnate or fall in the short to mid-term of 1-3 years. Therefore, only invest in SingPost if you are in for the long term and believe in SingPost’s future market position amidst Southeast Asia’s rapid ecommerce growth. However, in the short term it is more advisable to divest capital elsewhere and await more positive developments in the ecommerce segment before investing.
Fair Value: $1.360
I used a two-stage Dividend Discount Growth Model, with the first stage projecting earnings until FY2020 with a conservative CAGR of 5% to account for earnings to stabilize; factoring in lowering margins in eCommerce and logistiscs segment given increasingly competitive climate and decline in postal segment and increase in revenue of around S$10million in rental from SPC mall. The second stage will project a Gordon growth model.
WACC comes to 6.02%. Discount rate using CAPM model to calculate cost of equity (using SSB rate as risk-free rate and 10 year STI return as market return) arriving at 7.0%. SingPost cost of debt arrives at 1.92% with a weighted average of debt holdings.
Assuming conservative 2.0% terminal growth, fair value of SingPost arrives at $1.36 (0% upside). Hence, without any new developments SingPost valuation is fairly valued at the current market price.
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