Will UK Mail Deliver a Profit?

UK Mail (LON:UKM) claims to be one of the leading independent parcel, mail and logistics services companies within the UK and the main alternative to Royal Mail for business requirements.

Why Am I Interested?
It pops up on my new prototype screen (one of the '19' identified in Financial Ratios); Reasonable valuation/yield - PER of 13x and yield of 6%; and Cash generative and net cash on the balance sheet.  

Background

History & Business Model

The Business was set up in 1974 by Peter Kane, who acts as Chairman, and grew with the help of his brother, Michael Kane, who stood down as Non-Exec to retire in 2010. The Kane brothers and family hold 59% of the ordinary share capital of the Company. The Company is organised into four separate divisions: Mail - 45% of turnover and 7% operating margin - collects up to 17m mail items a day for over 1,000 corporate customers. Mail is sorted, consolidated and handed over to Royal Mail to deliver the final mile. Licensed by Postcomm (= barrier to entry); Parcels - 43% of t/o, 9% op margin - next-day B2B and B2C parcel delivery services; Pallets - 8% of t/o, 6% op margin - distribution of palletised goods through a network of 80 suppliers; and Courier - 4% of t/o, 13% op margin - same day delivery service.

The Business has grown turnover every year since 2001 (except for a flat 2010) and operating profit has been between £12m and £20m each year. Operating margins have fallen as lower-margin Mail has taken an increasingly large share of turnover, and there was a slight blip in 2006 when cost-cutting measures and price increases back-fired. The existing CEO joined at the end of 2005 and has grown PBT three-fold since then.

The Strategy is to strengthen its position as the "UK's leading integrated postal group" through (i) integrating the network (think IT) to make best use of resources (lowest cost) to deliver the breadth of services offered and (ii) increasing market share through new products and services. The Company changed its name from Business Post Group to UK Mail in October 2009.

Investor Relations is here

Share Price & Value

The current share price of 305p (mid-point as at 21 March) represents a PER of 13x and gives the Company a market value of £167m.   In the past three years, the shares have hit a high of 390p (Oct 2010) and a low of 255p (June 2009). The shares are 63% off the three year high.
M&G and Schroders hold just under 11% and 7% respectively. These two, the families of the founders and directors therefore control 75-80% of the ordinary shares, so there is not much left over for the open market...hence the large and nasty 3% spread on the bid/offer price.

Risks & Challenges

Competitive environment with pressure on revenues and margins likely to persist in short to medium term at least; the ability to pass on rising fuel and energy costs to customers; the UK mail market is in structural decline and is contracting at 5% pa - therefore innovation and product development will be important in growing market share (eg imail product - a web-to-print postal service), as well as diversification into new areas (eg April 2010 - signed a new contract with Royal Mail to operate a packet collection and delivery service); proposed privatisation of Royal Mail; and succession issues - for management and the share price - if and when the Kanes start to unwind their influence.

The Rules

The following analysis is based on the 12 months to March 2010 (FY10)

1 - Assets - NAV was £59m, meaning that the Company is being valued at 2.8 times asset value. £12m of NAV is in relation to Goodwill and Intangibles and £40m in relation to Tangible Assets, and of this c£18m is freehold land & buildings, which is pretty much the book value (£20m) they had attributed to them back in the 2000 accounts. I cannot see an open market value disclosed in the notes, but suspect that it is significantly higher than the carrying value in the 2010 balance sheet. Refreshingly, I cannot see too many nasties in the balance sheet either. Whilst I do not like a premium to NAV, I can just about live with it given that the premium to actual market value will be lower than  2.8 times. Pass(ish).

2 - Market Value - market cap of £167m. Pass

3 - Cash Flow - (a) net current assets of £16m and (b) operating cash of £29m after working capital movements. Out of this we need to cover: replacement capex (£7m - full capex) and tax (£5m - FY10 P&L), meaning that there is £17m left to cover working capital movements, investments for growth and dividends (£10m). Cash generation appears to have been consistently good, and can be seen by moving from a net debt position (£-9m) in 2006 to net cash (£+16m) - a £25m positive swing. Pass.

4 - Debt - (a) net cash of £16m and (b) Adjusted EV/EBITDA of 7.5x, which is not particularly cheap. For those who are interested, it gets a Piotroski score of 8, which is very good. Pass.

5 - PER - based upon FY10 EPS of 23.4p, the current PER is 13.0x, which is right at the top-end of where I would like it to be.  

The 10 year EPS is 18.6p, which equates to PER of 16x, which is neither cheap nor expensive. The PER (based on earnings at the time) has been in the range of 12x to 20x over the past decade. Pass

6 - Yield -  FY10 DPS of 18.2p equates to a yield of 6% at the current price. The dividend is covered 1.3 times. Pass

The 10 year average DPS works out at 17.2p, which is covered 1.1 times by EPS10 of 18.6p. Reassuringly, the 10 year average Free Cash Flow (FCF10) is 18.9p which means that the dividend has been covered out of cash (1.1 times) over the past decade.

The two issues I have are: (i) low cover - but I can get comfortable with this to the extent that dividend payments are important to the Company's major shareholders and a yield of 6%, whilst pretty generous, is covered by earnings and cash generation, and (ii) lack of dividend growth - the level of DPS has barely budged in 10 years. However, during this period and in the past five years in particular, the Company has been focusing on reducing debt and building up a cash pile. The 2010 dividend was increased (+6%) for the first time since 2006.

7 - ROE - was 22% in FY10 and ROE10 works out, spookily, at 22% too. The Company has consistently generated 'returns' for ordinary shareholders over the past decade. As an aside, ROCE10 is 35%, which is good. Pass

8 - Directors - executive remuneration is probably reasonable and there are bonuses linked to PBT targets (good for shareholders if set at appropriate levels), plus various options, LTIPs and other bits and bobs. The three executive directors hold c425k shares directly (£1.3m in value) and have options/LTIPs over another c300k (which are not under water). A slightly higher holding would be nice, however, the key drivers in this equation are the Non-Execs, principally the founding Kane brothers, who control 59% of the Company. This should ensure that a generous dividend remains.  Pass

9/10 - Buy or Bye? - an EPS10 of 18.6p and a PER10 of 18.3x gives a 'long-term fair value price' of 340p. The current price of 305p represents a 10% discount to this. Pass

Update

The interim results for the 6 months to September 2010 were released in November 2010. These showed modest turnover growth and continuing cash generation (cash balances £5m higher than H1 FY10), although gross margin was down. "The Board intends to pursue a progressive dividend policy". "Market conditions for the balance of the year remain hard to predict and...the final three months of the calendar year represent the key trading period for our business". A trading update was issued in January 2011 which indicated that volume was slow and had been impacted by the adverse weather conditions, resulting in full-year profit being broadly in line with FY10 profits. These factors were considered to be 'one-off' in nature, but the share price fell by about 10%.

Conclusion

The Company appears to be a profitable, cash generative and well-run family controlled concern. There is a growing cash pile and a growing dividend, albeit in the environment of challenging market conditions. The shares are not cheap, but are not expensive in the context of good and sustained shareholder returns (ROE). As ever, there will be interesting structural issues to play themselves out, particularly with Royal Mail, but UKM appears to be as well placed as any to face these. The question is do I add now or wait for the 'fat pitch'? I cannot see these trading at a discount to net assets or becoming a Net Net, so maybe I should live with a PER of 13x, which is towards the bottom of the 'normal' trading range, and wait to be compensated through an increasing dividend and ongoing ROE. I am going to dip my toe in and ADD at around 305p (+10p spread).  FY11 results should be released in May and there could be a further buying opportunity if the market gets spooked by seeing the Janaury 2011 trading update in the cold light of day.