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Although the share price of Deutsche Post (OTCPK:DPSTF) (translated: "German mail") has risen sharply since the pandemic, I think there is still room for growth in revenue and thus in share price. The business model was stable in 2020 and is now accelerating in revenue. Margins are improving as well. The company benefits from several global trends. Meanwhile, they are using the money to reduce debt and increase dividends.
To better understand the context, it is important to know in which areas Deutsche Post operates. The business model consists of both B2B (air and sea freight on a large scale) and B2C (doorstep delivery for both domestic delivery and e-commerce worldwide). Express deliveries can be both B2B or B2C.
Should we compare the 2021 revenue (especially Q2) with 2019 or 2020? We need to distinguish: The B2B business was hit very hard during the pandemic. The B2C sector, on the other hand, benefited from lockdowns and more online deliveries. The following illustration shows a strong decline in Q2 2020, followed by strong growth in Q2 2021. These are the figures we should compare with 2019:
In the B2C segment it makes more sense to compare with the strong Q2 2020 to find out whether this is a unique success story or a lasting, long-term trend. Here we clearly see the peak in spring of 2020. Nevertheless, 2021 revenues are significantly higher than 2020 in all months. YoY growth was 13% and management notes that they expect e-commerce acceleration will stick as a structural effect.
In the UK and the U.S., revenue increase is less rapid but 2021 parcel volumes are still higher than 2020. In the Netherlands and Eastern Europe, there is a clear upward trend. This suggests that there really is a lasting structural effect in these regions, which management has been talking about. I would like to note that Eastern and Southern Europe is still in its infancy as far as online deliveries are concerned. More on that further below.
As I mentioned earlier, Express deliveries can be both B2C and B2B. Compared to the previous year, this segment recorded balanced growth across all regions: Americas +37%, Europe +24%, Middle East & Africa +19%, and Asia Pacific +10%. This development is particularly pleasing as this segment contributes more than 50% to sales - as you can see below.
Let's look at the Q2 quarter and the YoY increase in each segment. All areas grew strongly - even the segments that were already pandemic winners in 2020. Earnings per share more than doubled vs. Q2 2020, which seems quite impressive.
OK, that was a lot of numbers. Now I would like to explain why I believe that this positive development is far from over. Deutsche Post will benefit from several global trends and technological advances.
E-commerce, both as B2B and B2C, are global trends that have barely begun in many developing countries. This includes most of South and Central America, Africa, a large part of Asia and even Eastern and Southern Europe. I personally know Southern and Eastern Europe very well through travel and friends and family who live there. E-commerce is still largely untapped (see numbers in the illustration below). Only now is the younger generation starting to use online deliveries.
In the past, we have seen in all developed countries that this is a one-way movement. E-commerce is simply faster, more convenient and cheaper. Once people start, they are unlikely to stop. Deutsche Post is very well positioned to benefit from this trend and is already doing so. As we saw above, "e-commerce solutions" contributed only 116 million euros to the total EBIT of 2083 million euros. But it grew from virtually zero to that figure. From zero to about 5% contribution doesn't sound so bad, does it?
Low e-commerce penetration, but 20% annual growth (2014-17). Source: McKinsey report
There is still a lot of growth ahead. E-commerce has some basic requirements to thrive: an intact infrastructure for deliveries, enough jobs so the people have money, working fast internet, and online bank accounts or fintech possibilities to pay. All these factors are improving year by year in emerging markets. They're also driven by massive investments from China in the context of its "Silk Road initiative" and, more recently, from Western countries as well. Within Europe there have been massive payments in the last two decades from the richer countries in the west and north to underdeveloped countries in the east and south.
Amazon (AMZN) is not the only company using robots in its warehouses. More widespread digitalization and the use of robots will lead to better margins. This is also already happening. Furthermore, it is expected that this will further improve delivery times, which in turn will increase the global willingness to order goods from all over the world. Alibaba (BABA) has announced the goal is 72h worldwide delivery; this will be the benchmark.
With more than 570,000 employees in over 220 countries, Deutsche Post is leading in more than 130 countries. Global supply chains cannot be created overnight. In addition, there are often long-standing customer relationships in this industry. Major customers would need good arguments to make massive changes to their logistics. In addition, setting up a new network is very time-consuming and costly and can only be done by a few companies. That brings us to the risks.
Above all, there are the two megacaps: Amazon and Alibaba. They are interested in taking their immense number of deliveries into their own hands in order to either be more in control of their own business, improve their margins and/or improve delivery times. Alibaba, through its investments and logistics subsidiary, Cainiao, could rival global integrators DHL, FedEx (FDX) and UPS (UPS).
At the moment, both companies are still working with DHL, but it is unclear how this relationship will develop in the future. Amazon has already been delivering some of its packages itself for years - also in Germany, which is an important market for DHL. There's now even an option for sellers on Etsy (ETSY) and Shopify (SHOP) to use Amazon's delivery if they use Amazon's fulfillment centers.
There is no doubt that we need to keep an eye on this development to see what impact it will have on Deutsche Post's business. A decline in sales will not be abrupt from one quarter to the next. Rather, these are slow, long-term developments, so investors will have time to react.
The looming competition already mentioned could have an impact on margins. This is something we will have to watch out for in the future. So far, this is not yet visible. Below we see the operating margin from 2014 to 2021. In this period, it grew from 5% to 9.63%.
In the growing geopolitical dispute over who will be the global superpower of the 21st century, there could be more national isolation. This could lead to permanently less trade and possibly the formation of groups (the U.S. and Europe, China and Russia, and so on). This formation is already happening. But when it comes to trade the whole world is still closely interconnected. China is looking for strong allies around the world and is investing billions in infrastructure in Asia, Africa, and South and Central America. This is all to promote trade, not to limit it. In this environment, the U.S. and Europe can hardly afford to stand apart. The already existing global economic network is enormous and there is mutual dependence.
Thanks to the increase in sales in recent years, there are good developments with regard to the company's debt. Since 2018 debt increased slightly (€12.3 billion to €12.9 billion) but EBITDA almost doubled. Estimated debt/EBITDA for 2021 will be 1.21x (2018 it was 1.91x). These are very healthy debt levels. Deutsche Post also has excellent liquidity: €5.1 billion in cash and cash equivalents on its balance sheet as of March 2021 and an operating cash flow of around €8 billion this year.
This cash flow, along with the company's cash holdings, will comfortably cover its €3 billion debt repayment over the next 12 months plus the estimated dividend payout of €1.7 billion. In addition, the company launched a share buyback program worth 1 billion euros in March 2021, to be implemented within one year. Fitch gave the company a BBB+ rating with a stable outlook. Debt repayments are spread very evenly over the coming years and are mostly in the range of 500 to 700 million euros per year. With a current operating cash flow of 8 billion, there is no reason for concern here.
Deutsche Post's target is to distribute between 40% and 60% of net income as dividends. On May 6, 2021, the Annual General Meeting resolved to pay a dividend of €1.35 per share (previous year: €1.15). Based on consolidated net income, the payout ratio was 56.2%. The current yield is 2.55%. As we can see, in the past the company did not increase the dividend every year. Instead, the leftover money was used to pay off debt and modernize the company. In my opinion, 40% to 60% payout ratio is the sweet spot: enough money stays in the company for growth and still the investor is rewarded. Because of this payout ratio in combination with growing profits, I believe that the dividend is firstly safe and secondly will continue to increase at a moderate pace - as it has in the past:
The company trades at a forward P/E of about 14 and trades at €53 ($62) per share. I'll use a simple discounted cash flow calculation to estimate the current fair value of the stock with these estimates:
This gives me a fair value of $66, which would mean the stock is currently slightly undervalued. Keep in mind that the past performance has been stronger and the company itself indicates an increase in profit of around 10% for this year. Also keep in mind the recently announced buyback program of €1 billion. Raising these numbers minimal to 6% for the next 5 years and 4% afterward gives a fair value of $89; I consider this still quite conservative.
Also, I'll use another valuation model: The Gordon Growth Model, which assumes that the company pays dividends that grow at a constant rate. I assume a dividend of $1.63 next year (an increase of 5% over this year) and thereafter also 5% increase per year. The current fair value of the stock would be $81.50, which would mean an upside of 31%. Of course, this method has its disadvantages. It assumes constantly rising dividends, and nobody knows whether this will happen. But the combination of this with the DCF method provides interesting conclusions. Here we can see that Deutsche Post is undervalued according to both methods.
In consideration of the opportunities of the globalized world and especially the emerging markets, I consider a purchase of DPSGY at a slightly undervalued price to be a great investment. Of course, this will not be a stock that offers considerable upside in the near future. But the steadily growing cash flow and rising dividends let me sleep well. If disruptive changes do occur, they will not come suddenly, but slowly over years.
Over the next few quarters, however, I will keep an eye on the e-commerce business and whether southern and eastern Europe will really be growth drivers. In addition, it will be important to see whether Amazon and Alibaba massively expand their delivery business and put pressure on margins. In the future, I plan to provide updates on whether these items improve or worsen.
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Disclosure: I/we have a beneficial long position in the shares of DPSGY either through stock ownership, options, or other derivatives. 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.