Perhaps the title above this article is a bit tacky considering PostNL (OTCPK:PNLYY) (OTCPK:TNTFF) (OTCPK:PSTNY) posts a new 52wk low quite often while the last fresh 52-week high was posted back in 2016. Nevertheless, the 52wk low of EUR 1.52 p/s last Friday and a rock-bottom valuation wakes up bargain hunters like myself. The key now is to identify whether PNL is a value opportunity or a value trap.
Source: Wall Street Journal.
PostNL was one of those high dividend value stocks, and now has a trailing dividend yield of about 15%. Following the recent takeover of its biggest domestic competitor in mail delivery, PostNL has to cancel its dividend in order to keep its balance sheet intact. Though this acquisition was well-received, the shares have slumped after Q1, contributing to the enormous trailing dividend yield.
Outlook vs Q1
Part of the current troubles with the share is the disappointing performance in Q1 versus the outlook. The outlook is added below for your convenience.
Source: PostNL website, accessed 8 June 2019.
I took the liberty of converting the outlook above to actual figures and put these next to Q1 results in the table below. Parcels are the most important to PNL because they will provide growth going forward, while mail is already written-off in the minds of most investors. This means that incremental gains or losses in Parcels move the stock. Unfortunately, it was Parcels that showed sub-par growth as well as a lack of improvement in cash operating margin.
Figures in red are added by the author and depict author's Q1 interpretation of 2019 guidance with revenue Parcels +11.5% and revenue Mail +5%, margin Parcels +100bps, margin mail -100bps. Source: PostNL Q1 2019 earnings release.
If we extrapolate this quarter into infinity we could reach the conclusion that the margin at parcels keeps eroding while mail has 10 more years of positive operating income at best. No one likes segments that suffer from eroding margins, even if depreciation (or CAPEX) is already accounted for, it does become more capital intensive and also more labour intensive for management and the rest of the organization to support that division.
It must be noted that PNL has international operations that is tries to sell (reported in Other) along with one international parcel segment it wants to retain (reported in Parcels), all of which are losing revenue in the last quarter and have been losing a lot of revenue in 2018 as well.
We can also take the longer-term perspective. For that, I have added parcel and mail volume charts below.
Source: PostNL 2018 annual report.
The trends from the charts above are quite clear. Revenue of Mail in the Netherlands is in a downward spiral, while parcels are on their way up. This makes me curious what this has done for their revenue and operating profit. Unfortunately, there is no 11-year overview of that in the annual report. I did collect figures from previous years and found that there is not a lot of progress on parcel operating income, despite strong revenue gains. It seems that, on average, operating income of Parcels increases by roughly EUR 5m per year.
Source: author’s own calculations based on annual segment figures as reported by PostNL. Numbers are (to a some extent) influenced by segment reclassifications and discontinued operations.
Mail has already come down a long way from what was a good starting point years back. Over the past 10 years, the division has been in a recurring cost-cutting cycle.
Value of parcels
My problem with parcels is the eroding margin, combined with continued needs for investments in PPE and working capital. The company publishes certain segment balance sheet figures, as shown below.
Source: PostNL 2018 annual report.
Piecing together capital needs, it seems that Parcels operates on a working capital of about zero while Mail NL is operating on a negative working capital and that is not great news as the division is shrinking. In fact, in 2018 we saw Mail working capital increase by EUR 89m to a negative EUR 274m. As Mail shrinks further, so will this negative working capital. In addition, the company as a whole spends about EUR 100m per year on CAPEX.
The acquisition of Sandd aside, my belief is that the value of Mail NL is not too far from book value. This segment, being quite regulated and fulfilling a public need, has a base line below which it will not go for a very long time. If needed, I am convinced the government will provide PNL with more leeway. My expectations for the coming years, assuming the Sandd acquisition goes through, are that PNL will raise prices for commercial use but consumer may enjoy stable prices. The market regulator, after approving the creation of a monopolist, will likely be less inclined to give said monopolist more leeway on the consumer side, or the mail delivery network it has to support.
Sandd has a mail volume share of about 40% in the Netherlands. The efficiency gains, along with possible price increases, will make the acquisition very lucrative. At this point, however, it is not certain if it will go through and what concessions the regulator will demand. PostNL is willing to pay an EV of EUR 130m, and for the time being I add half that amount to the NPV of PostNL. Obviously, Sandd is worth nothing standalone, but they are worth something to PostNL and the takeover price was probably based on the NPV PostNL would gain. So if half the total value of the deal was granted to Sandd’s current investors, another EUR 130m could be in it for PostNL.
Fair value estimate
The table below shows my estimates and calculation steps for a discounted cash flow model. I used EBIT instead of EBITDA as a base, which requires an awkward CAPEX adjustment below, but it aligns best with PostNL reporting. I also somewhat optimistically assumed that discontinued operations would cease to bother PostNL.
Source: author’s own calculations. A fundamental assumption is that Parcels will grow operating income by EUR 5m/year, consistent with the past 5-10 years. Mail will continue to dwindle until the government steps in to keep the network just marginally profitable by allowing either less service or straight subsidies.
A key underlying assumption is that Parcels will remain roughly as competitive and that margins will keep eroding at the same limited pace. Except for its existing size, PostNL has a limited competitive moat and it should be happy that it makes a nice return on capital there. There is no economic logic that would support higher or even stable margins as the market grows.
The assumptions for Mail may be somewhat bullish, considering the expected volume declines, but I still find it unreasonable to assume that a regulated monopolist will become loss-making. As PostNL rightfully pointed out, a private company can’t reasonably be expected to keep incurring losses on an activity. What doesn’t help PostNL though, it that management refuses to consider splitting the company because it believes there are synergies between mail and parcel delivery.
The small table below shows my fair value estimate of PostNL. I simply discounted the cash flows in the table above, along with a zero-growth terminal value and subtracted Q1 net debt along with the cash part of the dividend paid in May. As the value that Sandd will bring is highly speculative, I pencilled in EUR 65m - half the deal EV – as a start. But again, we don’t know what restrictions the regulator will place on PNL in exchange for approving the deal. I do find it likely that the deal will go through, as PNL is fairly well connected to the government and probably gets approval.
Figures in EUR mln except per share amounts. Source: author’s own calculations. Share count used is 485m; the discount rate used is 8%.
I admit that my cash flow forecast is a bit rough, but I’m convinced that finetuning it would lead to adjustments both up and down and I would end up not far from where we are now. Equally important is at what conditions the Sandd takeover happens and when dividends will be resumed.
The obvious ‘value trap’ days of PNL are over. Many investors have wrongly bought this stock in the past, foolishly believing that operating income of Parcels would grow steadily while Mail could maybe stabilize. These investors have made room for investors who accepted reality and price the stock accordingly.
At a fair value of EUR 1.70 or maybe 1.83 /share I still struggle to call this a very convincing buy for any investor. This is a stock that needs room for error and the current upside of 10-20%, doesn’t leave a lot of room for that. The discount rate I used is also on the low side. On the other hand, I do believe my assumptions are reasonable, and the Sandd acquisition can become major bonus. PostNL is still a nice bargain for value investors who like living on the edge and believe the company will manage to control costs well while volumes and pricing are under pressure. I could be a buyer below EUR 1.50 /share, and considering the stock’s track record, that is approximately this Friday.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.