Description
Summary: DSV is a global freight-forwarder making the transition from a traditionally European/road-focused forwarding operation to a global provider of integrated forwarding solutions (road, air, & sea) with offices in more than 50 countries around the world. Profit contribution for the business is approximately 50% air and sea, 40% road, with the remaining 10% largely a contract logistics business. DSV's share price declined precipitously as investors reacted to the combination of leverage following the poorly timed (Summer 2008) ABX acquisition and significant global trade volume declines. However, the market is not giving credit to the synergies to be generated from ABX and the quality of the forwarding business. We believe that DSV is worth 120 DKK a share based on a 12x multiple of post-synergies free cash flow, a 60% return from the current share price.
Freight Forwarding has Attractive Business Characteristics: Freight forwarding is the purchasing of transportation space from asset-owners, consolidating full or part-load shipments from customers and delivering to a specified destination. Freight forwarders benefit from globalization which has historically resulted in world trade growing at nearly twice the rate of GDP growth. Additionally, the highly fragmented freight forwarding market (top 10 players accounting for < 20% for sea and road and ~50% for air) allows scale players to gain share from mom & pop competitors. Scale advantages arise from a combination of (a) upfront investments in IT infrastructure/systems, (b) purchasing power on freight capacity, and (c) possessing a global network necessary to serve large multinational customers. DSV is one of the premier forwarders that can provide the global integrated services of road (#2 share position in Europe), sea (#8 position worldwide), and air (others include Kuehne & Nagel, DB Schencker, and DHL). Finally, freight forwarding is an asset-light business that generates high returns on capital as minimal incremental investment is required to grow the business.
Focused Management Team and Operational Efficiency: The DSV management team has a strong operational background and runs a highly entrepreneurial organization with a focus on bottom line performance. One of our contacts referred to DSV as the Ikea of freight forwarding with the "right price, right quality, right time." Historically, this has proven out in DSV's better than industry average margins. These margins are further bolstered by DSV's dominance in the Nordic region and focus on more profitable small and midsize customers.
ABX Transaction Synergies: DSV purchased ABX Logistics, an air and sea-focused freight-forwarder with operations largely in Southern Europe, from the private equity firm 3i in October 2008 for just over $1 billion. Management has guided to 750 million DKK of cost synergies largely from branch closings and personnel reductions with the acquisition. DSV has a strong M&A track record with a demonstrated ability to integrate acquisitions effectively and to achieve or surpass synergy expectations provided to the market. Our research on the ABX assets indicates that there is substantial synergy between the two businesses. Headcount reductions of ~15% have already been achieved, and the company recently increased its target to closer to 20%.
Return Profile: We anticipate that DSV can grow its top line at GDP plus levels given its strong market position and favorable secular growth characteristics. During the first half of 2009, global trade volumes declined anywhere from 15-25% depending on the mode of transportation. DSV outperformed these market declines by approximately 600 bps and 750 bps in sea and road, respectively. We believe that DSV's forecasted long-term growth rates of 3-5% are reasonable, and therefore model a 4% growth rate off of depressed 2009 levels. Additionally, we credit the company for substantial cost synergies discussed above, and project 2 billion DKK in free cash flow generation in 2012 (as synergies roll through progressively over the next 18 months), or approximately 10 DKK per share. If you assume a 12x multiple on this post-synergies FCF, DSV is worth 120 DKK a share, a 60% return from the current share price. Kuehne & Nagel and Expeditors, two of the leading asset-light competitors, trade at 16x and 21x 2011 consensus EPS, respectively.
Investment Risks: Cost synergies are a significant driver of our estimated earnings improvement for DSV over the next few years, creating a risk of poor integration execution. Our research indicates that management is very conservative in their guidance and has an excellent historical record successfully integrating acquired businesses, so we believe that stated synergy levels may turn out to be low. The second primary risk for DSV is balance sheet risk, as the company is currently levered at less than 3x EBITDA. DSV does not have significant near-term amortization requirements (€200 million in 2010 and 2011) and has been pro-active in addressing this issue with a €200 million equity raise earlier this year. The company has generated substantial free cash flow this year, actually expanding margins by negotiating aggressively with suppliers, and should de-lever to 1.5x EBITDA by the end of 2010. However, the business is economically sensitive, so a further downturn in the worldwide economy may highlight the financial leverage that the company possesses.
Disclosure: We and our affiliates are long DSV. We may buy or sell shares in the future. This is not a recommendation to buy or sell shares.
Catalyst