CTI's road to expansion

CTI Logistics (CLX) has remained under the radar for much of its time since listing in 1987. Recent events suggest its profile is rising, and the company will look to address the stock liquidity issue due to the high level of management ownership.

With share price catalysts via Chevron’s Wheatstone liquefied natural gas project in the North-West of Western Australia, and through the unlocking of “hidden” land value, we have a buy recommendation with a $2.80 sum of parts (assets-based) valuation.  The company is currently trading at $2.33.

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CLX's suite of transport services includes a leading Perth-based on-demand courier business, parcel distribution, and line-haul freight.  While the courier business is mature, it provides reliable cash flow and the company has flexibility to adapt to market conditions through its use of sub-contractors. The parcel distribution business is well placed to benefit from the shift to online retail sales. Line-haul freight services are also expanding due to management’s focus on increasing its regional depots to enable a greater reach in Western Australia. 

In regards to logistics, the division comprises warehousing and distribution, as well as servicing large LNG projects. Increased customer demand for contract warehousing and third-party distribution centre management has driven management to expand its capabilities.

The $14 million stage 1 development of the 54,000 square metre Hazelmere site (near Perth airport) was completed in FY13. Key warehousing customers include Mitre 10, Target and Bunnings. The $50 billion Chevron-owned Gorgon LNG project also has been a major area of growth, with the company successfully providing warehousing management and various preparation services for equipment going to site. The $30 billion Wheatstone (also Chevron-owned) LNG project provides a greater earnings opportunity than Gorgon due to the likelihood of CLX winning a wider range of logistics work.

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Logistics will comprise a greater component of future earnings due to at least another four years of LNG-driven growth, and increased distribution and warehousing demand. The company’s property division comprises rental earnings on its investment property, and “other” comprises non-core security and plastics businesses.

There are two key recent events that demonstrate the increasing awareness of the company’s brand and capabilities. Firstly, BHP Billiton recently approached management to complete warehousing management work after hearing positive feedback from customers at Gorgon. Secondly, a capital raising was undertaken in August due to an approach from a major international fund manager, which appears to have taken extra care to remain unidentified. The fund is likely sitting on just under the 5% compulsory disclosure level and also completed the capital raising directly with management, rather than through a broker, to buy the shares at $1.85 (above the market price at the time).

Management has effectively been operating as a private company, with the chairman David Watson owning approximately 45% of the company, and the joint managing directors – David Mellor and Bruce Saxild – owning a combined 15%. However, there is reason to believe this may change.

All three have been with the company for over 30 years and have begun succession planning. The next 15 people in the middle management team have been with the company on average 19 years, with most aged in their 40s. The experienced and capable middle management team suggests the group is well placed to continue the long history of exceptional earnings growth and of providing value to its growing customer base.

The WA transport and logistics market is extremely fragmented, with approximately 1,100 players – many of whom, are considerably smaller than CLX. Increasing scale and integration of the supply chain are the two key drivers in the sector to enable competitive pricing and efficiency gains for customers. Given this industry dynamic and recent increased investor support, there should be no shortage of opportunities in coming years for management to consider exit strategies and to address the current liquidity concerns due to a lack of free stock float. Balance-sheet capacity can also be increased by a sale or the sale and leaseback of land assets.

In regards to competitors, CLX is positioned in the middle of the market, playing second-tier to Toll, Linfox, DHL and UPS. However, it has enough scale and capability to compete on price. Many of the companies smaller than CLX are struggling to compete. With industry demand trending towards larger integrated companies with a recognised brand, consolidation is likely to continue. Recently K&S Corporation (KSS) merged with Scott Corporation (SCC) through an off-market takeover offer. Whilst operating primarily in different markets, Qube Logistics (QUB) has increased its market cap from $200 million to approximately $1.8 billion with an acquisition strategy the largest driver of its growth.

By way of example, CLX management previously didn’t have capabilities for trucking freight from the Mitre 10 distribution centre it was operating to retail stores, and instead was passing the business onto Bunbury Freight. This triggered the accretive acquisition of Bunbury Freight, which now provides a more integrated efficient solution for its customer. 

The acquisition strategy also has merit in expanding its freight network via depots in Hazelmere, Welshpool, Bunbury, Karratha and Broome to increase the amount of line-haul services. The heavy truck fleet recently expanded with the acquisition of a number of trucks and trailers from a company in liquidation to bolster the expanding North-West operations.

The customer base is diversified, with no single customer comprising more than 10% of earnings. Recent contract wins/expansions with Adelaide Brighton, Target, Nufarm, Thiess and BHP add to an impressive list of approximately 5,500 customers.

CLX has a history of conservative accounting, with land value remaining on the books at cost value, and a high percentage of its asset base being tangible. In regards to the land, it has a book value of $46 million vs. an estimated market value of $78 million ($1.20 per share). After tax and potential transaction costs, this suggests there is approximately $24 million of “hidden value”, or 40 cents per share.

There is also a land development opportunity at the head-office site, with potential to make use of the spare 6,600sqm of land. The company can shift its head-office to the company owned land next door, and the local council is encouraging the development of residential units on the current head-office site.

The 70.3% gearing (net debt/equity) is less severe than it appears when considering the understated equity component of the balance sheet. We are also forecasting gearing to reduce to 50% in FY14 as a result of debt reduction due to free cash flow, and an increased asset base from the warehousing development of the Hazelmere site. Operating cash flow will remain strong, and ensure a continued ability to maintain a 40-50% dividend payout policy.

Our $2.80 valuation and target price is based on a sum-of-parts methodology, to appropriately capture the hidden land value. With conservative earnings forecasts, and continued benefits from increased scale, CLX presents a compelling long-term buying opportunity.

With a forecast dividend yield of 3.4%, our $2.80 price target represents a potential 23.5% total return.