In a recent issue of European Value Report, the research team of The Manual of Ideas outlined an investment thesis on Austrian Post, pointing out the incumbent postal service provider's strong cash flow generation and growth opportunities in Eastern Europe. Key excerpts follow:
Austrian Post shares offer a compelling investment opportunity based on: 1) strong cash generation; 2) a solid balance sheet; and 3) attractive valuation. We estimate the shares are worth up to double the current market price, with minimal risk of permanent impairment of capital.
Strong Cash Generation
The company has generated €868 million of free cash flow from 2004 through 2008, representing two thirds of current market capitalization. While the trading environment is more difficult this year, with revenue down 4% in the first half, we expect the business to remain highly cash-generative in the future.
In fact, management has several levers at disposal to increase cash generation over time. On the revenue side, a key driver is the core mail delivery business which accounts for 60% of the company’s top-line. Stamp prices were last raised in 2003 leaving room for another increase. In parcel delivery, the company is well-positioned to take advantage of growth trends, especially in Eastern Europe.
On the cost side, the main challenge is managing staff costs, which represent roughly 50% of revenue. As just over half of the 25,900 employees are civil servants, who cannot be laid off according to law, management’s options are limited. Nonetheless, the company has been aggressive with cost-cutting initiatives, targeting €30 million of non-staff cost savings in 2009 and pledging ongoing workforce reductions in the next years based on normal staff fluctuation. New CEO Georg Polzl, who started on October 1, brings restructuring experience from his prior role at Deutsche Telekom and is set to continue taking costs out.
Solid Balance Sheet
For a stable, utility-type business model, it is surprising that Austrian Post has a net cash position (€130 million as of June 30). The one liability of note is a provision for “under-utilization” of civil servants. Essentially, this is the present value of salary obligations toward civil servants who are not needed in the business, but remain a responsibility of the company until they retire. The liability, which is currently €286 million based on a 5.5% discount rate, covers about 500 civil servants. We think the company can effectively manage this liability by having civil servants retire early or leave the company for another job over time.
At €20 per share, Austrian Post offers an 8% FCF yield based on last twelve months’ free cash flow of €101 million (down €73 million from its 2004-08 average). The current dividend yield, based on the regular €1.50 per share dividend, is also 8%. The dividend is well-covered by long-term cash generation prospects of the business and the healthy balance sheet.
In addition to the above-mentioned levers to increase cash-flow over time, a significant opportunity is also presented by the Parcel & Logistics and Branch segments. While the two segments accounted for 40% of revenue, they contributed only €1 million to LTM EBIT. We think both segments can achieve mid-single digit EBIT margins in future, consistent with their 2004-08 average margins.
Austrian Post is a “cash cow” with a near-monopoly position in its core domestic mail delivery business. Trading at a mid-teens normalized FCF yield, the shares offer an exceptional risk-reward, especially after taking into account the unlevered balance sheet. With prospects of not only maintaining, but also growing free cash flow over time, the current 8% dividend yield is compelling.
Disclosure: No position.