Qube: The power of integrating supply chains

The Qube logistics (QUB) full year result further enhanced my view that the company is one of the best long-term investment opportunities in the logistics/transport sector.

Revenue was $1,212 million against my forecast of $1,201 million, and underlying net profit after tax (NPAT) was $88.6 million versus my forecast of $88.5 million. The full-year dividend of 5.1 cents a share was slightly higher than my 5 cent a share forecast.

Underlying earnings per share of 9.3 cents equates to 16% growth for the 2013-14 year, and I am forecasting another 17% growth in earnings per share for FY15.

With a market cap of approximately $2.5 billion and 3,400 staff, the national operator is increasingly diversified by location, sector and customer base.

As discussed in my initial recommendation on May 28, Chairman Chris Corrigan is taking a back seat role in comparison to his influence with Patrick. It is Corrigan’s former Patrick executives – a long list led by chief executive Maurice James – who are now driving Qube’s success.

One of Qube’s standout features is management’s ability to grow revenue and margins even when industry conditions are not supportive. The fact Qube can grow regardless of macroeconomic conditions is a reflection of their expertise in finding strategic acquisition opportunities, of benefiting from increased scale and from identifying more efficient solutions for its customers.

The fortunes of mature peers such as Asciano (AIO) and Toll (TOL) are much more reliant on industry volume growth. This fact, as well as the value of Qube’s strategic assets that are yet to become operational, means Qube should trade at a price-earnings premium to them and other industry players.

In the half and full-year reporting periods since 2009, I can’t recall many if any times Qube results have been below expectations. With the share price increasing about five times in that period, there have been surprisingly very few BUY recommendations from broking analysts.

Maybe that is because management doesn’t seek or need the support of brokers. Guidance is usually just a general “earnings will grow” and getting any detailed guidance on items such as earnings margins, or earnings sensitivities is like getting blood out of a stone.

Some will criticise management for their lack of engagement with the investment community. However, given many of the growth opportunities are competitively sensitive, you can understand why they let their results do the talking.

Another reason why the company is not dependent on broker support is the long list of strategic shareholders who are happy to step up whenever there is a requirement to raise equity for acquisitions or other strategic initiatives. This shareholder list includes Carlyle Investment Partners with 12.5%, Taverners with 5.5%, and key customers who are also substantial shareholders in Wilh. Wilhelmsen and Kawasaki.

When I first recommended Qube as a BUY at $2.36 on the May 28, one out of the 10 analysts listed on Bloomberg had a BUY recommendation. Today there are now four out of 12 brokers with BUY recommendations. Maybe the analysts are finally beginning to understand why Qube trades on a high short-term PE and why they are likely to keep outperforming.

Recognising the longer-term opportunity

To understand the company, it is best not to focus on the one-year earnings forecast. Instead it is more helpful to understand the strategy and management’s wide range of capabilities to gain confidence as to why continued long term revenue and earnings growth is likely.

The vision is to be Australia’s leading provider of integrated logistics solutions focused on import and export supply chains. This means to benefit from the current inefficiencies in port related import-export supply chains, with a particular focus on containers, automotive, and bulk commodities. In a fragmented transport and logistics industry, the aim has been to integrate the supply chain both by acquisitions and organically.

As the integration has developed it has enabled Qube to provide more efficient solutions to customers. The good news is the contract wins and growth will continue because the penetration across most segments is still relatively low.

Including acquisitions, Qube has invested about $800 million since September, 2011. The track record of increasing margins and growing return on equity is largely due to efficient allocation of expansion capital expenditure (capex) in combination with the strategic acquisitions. Annual capex is expected to continue at a rate of $200 million, with only $40 million of this allocated to maintenance. Net debt of $280 million is well below the target 30-40% gearing range (there is capacity of a further $330 million of debt to get to the bottom of the range).

Growth from each division

Qube has two key operating divisions: “logistics” and “ports & bulk”. While the operating divisions continue to increase revenues and margins, the company is also progressing its strategic assets to becoming operational.

In logistics, the key focus is transport and related services for import and export containers. This includes both road and rail, with the division recently expanding into bulk rail. The outlook for 2014-15 includes improved rural volumes (grain, cotton, sugar) and increased contribution from rail activities. The expectations for organic growth are despite no significant improvement in overall container volumes through ports.

In ports & bulk, there is a network of businesses that include stevedoring and related import/export logistics for automotive, general and bulk cargo. The division has recently expanded into oil & gas which, along with bulk logistics, is likely to drive the growth in 2014-15. In the more mature auto sector, growth is subdued but the division is maintaining market share.

Finally, with the “strategic assets” division, Qube has majority ownership of two sites in Sydney. These sites provide rental income at the moment, however, there is large earnings upside if they can be developed into operating terminals.

Moorebank is the larger and most valuable of these two land assets. The site is likely to be developed into the country’s largest inland intermodal terminal, with an ideal location west of Sydney between the government-funded $1 billion Southern Sydney Freight Line (SSFL) and the major M3 and M5 roadways. The terminal is an important government priority due to the need to allow a greater modal shift road to rail and reduce the road congestion around Port Botany.

The Sydney Intermodal Terminal Alliance (SIMTA) is the joint venture for the Moorebank development (Qube has a 67% stake and Aurizon holds 33%). The joint venture recently made significant progress, with the federal government selecting it for exclusive negotiations for a major logistics precinct that combines with the government-owned site located next door. The aim is to finalise mutually acceptable negotiations by the end of the year.

A near-term catalyst

Successful completion of Moorebank negotiations would be a strong catalyst for Qube, with long-term large earnings upgrades to follow.

The other development within the strategic assets division is the establishment of Quattro – another joint venture which Qube has a 37.5% stake in with three grain industry players including Noble Group. Quattro will develop a new grain storage and handling facility at Port Kembla. The model is scalable and they are actively seeking opportunities to replicate the facility in other states.

Management continues to expect the strong growth rates to continue, with both operating divisions to deliver revenue and earnings growth.

I maintain my long term BUY recommendation with an increased valuation and target price of $2.70 (from $2.60).

To see Qube Logistic’s financial summary and forecasts, click here.