Logistics group on a bumpy road

CTI Logistics is expanding … but its biggest challenge is a shrinking WA economy.

Summary: The Western Australian economy is contracting, in line with the mining sector. WA company CTI Logistics has been expanding to meet growing demand for courier and logistics services. But despite an impressive track record, there are potential speed bumps ahead.
Key take-out: While growing its operations, CTI has delivered flat earnings per share and faces deteriorating conditions in WA. It is also a relatively illiquid stock, with management controlling more than 50%.
Key beneficiaries: General investors. Category: Growth.

In the first week of June, the Australian Bureau of Statistics released data that showed the Western Australian economy contracted over the March quarter.

I have been warning that the WA economy is heading for a recession, and I’m not about to change my tune. Just think: if the economy was slowing in March, how do you think it has performed during the June quarter when miners and mining servicers have been announcing earnings downgrades on a weekly, if not daily, basis?

The WA economy is like a bathtub of warm water. In it are the companies – fish of varying sizes – swimming around searching for morsels. The only problem is that the plug has just been pulled. As any keen student of hydrodynamics, or anyone studying the path of soap in a bath – can attest, the smallest fish get sucked down first even as they try and fight the current, and eventually there may not even be enough water for the bigger fish to enjoy good health.

The impact will have far reaching consequences for the economy. Just take a look at NRW Holdings Limited (ASX:NWH), which yesterday joined a long list of resource and mining service companies materially downgrading their outlooks with the release of a “FY13 Guidance Update”. Notwithstanding my very many repeated warnings about the demise of the prospects for the mining services sector, the NWH share price has now declined 77% from $4.36 in March 2012 to the current $1.01.

Despite the gloomy bathtub analogy however, and the bitter experience of some companies, there is one company that has the experience to survive the outgoing tide. It is CTI Logistics. The company has (literally) been a driving force in the Perth marketplace, providing transport and logistics services since 1974. CTI has built a solid reputation for reliability by refusing to deny any requests made by its customers. This strong reputation, combined with prudent management, has translated to very impressive returns for the company – CTI’s earnings per share has grown at a compound annual rate of 25% since 2004.

At its core, CTI Logistics is a courier that controls 35% of the “on-demand” market in Perth. Rather than compete directly with Australia Post and TNT, who have international networks, CTI is content to serve as a back-up to these distributors. This is because Australia Post and TNT do not have the capacity to handle the volume of parcels flowing into WA. The courier market is a mature industry, but it generates considerable cash flows, which have funded the company’s expansion into logistics.

CTI originally expanded as an overflow-warehouse, though quickly won tenders to provide complete third-party warehousing services. CTI has sufficient capacity to expand this business – it owns 54,000 square metres of land just outside the Perth airport, upon which it has just built a 9,000 square metre warehouse to service Mitre 10 and Target.

Companies are knocking down its door with logistics requests, and management is hoping to fast-track plans to build another 20,000 square metre warehouse on the site (management has stated that their only real impediment to growth is the speed at which the local government approves development).

Specialist haulage will be the next major growth driver for CTI Logistics. The company has recently acquired road-train operators that service the major oil and gas projects in the state (management do not want exposure to iron ore, which is a definite positive in my eyes).

The acquisitions extend CTI’s network to the south of Perth and to the top end of the state. Once the acquisitions are operational, management has plans to build further hubs in the Northern Territory – as the hubs within its network increase, so does the scalability of the business. Management expect that specialist haulage will be just as profitable as its courier division, and the earnings will be relatively insulated from a downturn since the gas projects have committed capital for several more years.

But despite its impressive track record and competent management, there are two reasons that I have decided not to invest in the company.

First, CTI Logistics does not satisfy my liquidity requirements for inclusion in my funds. While the company has a market capitalisation of $100 million, management hold over 50% of the shares outstanding, which would make it difficult to exit any investment in a timely manner.

The second reason is the deteriorating conditions in WA. While the company has potential, it is not completely immune to a downturn. The company’s earnings flat lined during the GFC – earnings per share was 8 cents in 2008, 7 cents in 2009 and 8 cents in 2010.

I like CTI Logistics, but rather than playing Russian roulette while the plug remains removed, I’d prefer the safety of cash.

Roger Montgomery is the founder of The Montgomery Fund. To invest, visit www.montinvest.com

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