Shares digital

It would be easy to assume a rise in the price of oil spells trouble for the sector, but all is not doom and gloom. Strong balance sheets, acquisition opportunities and passenger growth are just some of the positives to be found in the sector.

by Rachel Robson

Even after the $20 pullback seen in the past two weeks, the price of a barrel of brent crude oil still costs 70% more than it did a year ago. The resultant rise in petrol and diesel prices has not only hit car owners where it hurts but has placed increasing pressure on the UK’s quoted transportation groups, too.

The industrial transportation sector has therefore underperformed the FTSE All-Share index this year and lies 29th out of the 39 sectors tracked by Shares. It would be easy to assume a rise in the price of oil spells trouble for every company in the sector, but all is not doom and gloom. Strong balance sheets, acquisition opportunities, passenger growth, and booming demand for iron ore and coal are just some of the positives to be found in the sector.

Investors should therefore look to hitch a ride with shipping broker and consultant Braemar, marine services expert James Fisher and supply chain solutions expert Wincanton. Exposure to sagging airline stocks, the stumbling Spanish economy and ailing auto demand mean Dart Group, Northgate and Autologic remain stocks to avoid.

Should the oil price pullback prove long lasting, as Lehman Brothers’ $90 price forecast implies, then the sector can be expected to erase much of 2008’s underperformance at speed.

Passengers paying the price

Higher fuel prices mean companies such as Go-Ahead, National Express and Stagecoach will have to work harder to find ways to offset the impact of increasing costs.

Their most obvious solution is to increase bus fares and leave passengers to bear the brunt. This strategy has worked so far, as higher fares have yet to act as a deterrent to passengers. In fact, it seems more and more people are dumping their cars in preference for the bus, train, or simply walking.

Investec analyst Joe Thomas, says the buzz word in the sector at the moment is ‘modal shift’, pointing out there is ‘a good case for people shifting out of cars and on to buses and long-distance trains’. Gert Zonneveld of Panmure Gordon concurs. He explains a combination of environmental concerns road congestion and high petrol prices are persuading people to use public transport. Rising fuel prices could therefore work to the rail and bus operators’ advantage.

The switch from car to public transport is not particularly surprising according to Collins Stewart’s Andrew Fitchie who points out: ‘A monthly bus pass now costs the same as a tank of petrol for a car.’

Investec’s Thomas is less convinced people are moving on to commuter rail, which could be impacted by redundancies in the City. Those transport groups with commuter rail franchises, such as Stagecoach which operates South West Trains, could suffer if City job losses escalate as this means passenger volumes could start to decline

It also remains unclear how much longer bus and rail companies will be able to push up fares if the oil price remains high. Many companies remain optimistic they can, but failure to do so would mean they risk a squeeze on profit margins.

Hedging their bets

Many bus and rail groups rely on fuel hedging to help keep costs to a minimum. Go-Ahead recently reported it has bus fuel hedges in place for 100% of next financial year’s requirements at an average of 43p per litre, as well as 50% of the following year at an average of 52p per litre. National Express is currently 85% hedged for 2008 and 40% covered for 2009.

‘There is no doubt higher fuel prices create a challenge for companies, but there is hedging in place to provide some certainty for this year and this gives them the breathing space to raise fares now in anticipation of future higher costs,’ says Peter Caldwell of Barclays Wealth Research.

This will provide an element of protection, but will not leave companies completely unexposed.

On the cheap

Despite company optimism, Collins Stewart’s Fitchie points out bus and rail stocks have ‘fallen on average 25% over the past six to nine months on (so far unwarranted) fears of a demand slowdown and fuel cost pressures.’ As a result, FirstGroup, National Express and Go-Ahead Group all trade on a prospective price/earnings ratio (PE) of just 11 times for 2008 and this looks to be a buying opportunity.

Collins Stewart’s Andrew Fitchie reckons FirstGroup is the ‘only stand-out buy’, and the stock is also favoured by Panmure Gordon’s Gert Zonneveld who argues it has good exposure to the North American school bus market which is performing well. In addition, only 25% of the Aberdonian firm’s profits are generated by rail, with just a fifth of this figure (or around 5% to 6% of group profits) coming from commuter rail. It has also underperformed its peers.

National Express has been picked out by Investec’s Joe Thomas as he believes it is ‘trading at an unfair discount to others in the sector’. He comments the group has a solid business in Spain, where the revenue base should be supported by continued population growth and a ‘helpful government policy’ despite concerns about the marked economic slowdown seen on the Iberian peninsula this year.

The logistics

Logistics companies and supply chain solution providers such as Stobart and Wincanton are also feeling the pinch from rising fuel costs. Their share prices have suffered as a result. Stobart in particular has taken a pounding, falling from 148p in April to 94p. Peer TDG has put in a better performance, aided by takeover talk.

Both Stobart and Wincanton remain fairly bullish about the outlook. A recent trading statement from Stobart revealed it is protected from fuel increases and has fuel price escalators in customer contracts. In addition, the company continues to trade in line with management expectations and remains confident its ‘strategy of developing a truly multimodal transport and logistics offering will enable the group to deliver further profit growth over the course of this financial year.’

Wincanton, too, is growing rapidly, and continues to build up a strong portfolio of customers. The group also remains focused on passing fuel costs on through its customer contracts, providing it with an element of protection against the high oil price.

Smooth sailing

One area that is enjoying buoyant trading conditions is the shipping industry, helped by rising demand in China and India for dry-bulk products such as coal, iron ore and agricultural crops. As a result, shipping stocks have powered ahead since February, a move reflected by an enormous bounce in the Baltic Dry Index (BDI), which benchmarks the price of chartering a ship. Since its January low of 5,615 in January the BDI has surged 58% to 8,856, although even this represents a pullback from the all-time high of 11,793 reached in May. Alex Chan of NBG International explains this surge is due to the conclusion of iron-ore price negotiations between Chinese steel mills and iron ore producers, as well as port congestion.

Boosted by rising charter rates, Braemar Shipping’s shares have steamed ahead 15% this year, but this has been easily outstripped by a 48% rise from Greek-based shipping group Global Oceanic Carriers, where takeover talk has further boosted sentiment.

Transportation provider Globus Maritime shares have done well since their flotation last June as they have bobbed up from 300p to 395p, despite a recent pull back. The £113 million cap has already expanded its fleet to eight modern dry-bulk carriers and during the first quarter of 2008, fleet capacity utilisation stood at 98.3%, against 84.8% the previous year.

Shipping stocks could see a softening in demand this summer. According to latest Chinese customs data, China’s iron ore imports totalled around 37.8 million tonnes (mt) in June 2008. This is a 41% year-on-year increase, but Alex Chan of NBG International points out it still represents a 5.1mt decrease from April’s record high. ‘I expect to see some further tapering off over the summer months in terms of imports given the high inventory levels at present, and some slowdown in steel production in China given the 2008 Beijing Olympics,’ says the analyst. ‘Some steel mills around and in Beijing have been shut ahead of the Olympics to improve the air quality surrounding the Olympic site.’

Chan remains bullish in the short term on the ‘fundamentals for dry-bulk commodities and for the environment to pick back up following the summer months.’ He also expects the Chinese to increase its imports of raw material ‘to support the country’s infrastructure development, especially post-earthquake [the re-construction of Sichuan Province].’ The onset of winter in the northern hemisphere should also further stimulate the movement of coal.

Tight supply

Strong market conditions in the dry-bulk market are also being exacerbated by a shortage of adequate vessels and a lack of port infrastructure and demand. Freight rates are therefore likely to remain high for the next couple of years, at least until vessel supply significantly rises.

Panmure Gordon’s Gert Zonneveld highlights a lot of new capacity is due to come onstream in 2009 and particularly 2010. He believes it will be ‘impossible for new capacity to be absorbed without having an effect on freight rates’, but does acknowledge scrapping of old vessels could provide some relief. (Vessels should be scrapped after 25 years, but this does not always happen.) In addition, Zonneveld points out around 20% of the new capacity is due to come from Chinese yards which have not built vessels before. As a result, the new ships could be delivered later than expected and in smaller numbers.

Takeover targets

The transport sector as a whole has seen its fair share of merger and acquisition activity over the past year and further deals are likely. Wincanton made a play for rival supply chain manager TDG earlier this year, only to then conclude such a deal was not in the best interests of its shareholders. TDG has since agreed to be bought by the hedge fund Laxey Partners for £203 million.

Global Oceanic Carriers also recently agreed terms of a recommended 170.5p per share cash offer from Newport Holdings, which values the bulk carrier owner and operator at £68.3 million. The bid offered investors a juicy 29% premium over the closing price on the day before the deal was announced (27 June).

Meanwhile, back in March, Arriva snapped up bus and coach operator Tellings Golden Miller. Ferry operator Irish Continental has also been under the spotlight, undergoing takeover talks for around seven months last year. Both Aella and Moonduster were interested in the company but talks eventually collapsed last October. Despite such disappointments, lowly valuations and the search for complementary businesses should ensure further deals get done before the end of the year.

TRADES TO MAKE THIS WEEK

Braemar Shipping Services 535.5p, BUY

Profits ahoy

A lowly valuation, fat order backlog and growing addressable markets all bode well for Braemar Shipping Services, a Shares (1 November 2007) ‘Play of the Week’. Braemar provides broking and consulting services to the global shipping industry and its business is based on four segments: shipbroking, logistics, technical services and environmental services.

The company’s forward order book has remained strong, and the group highlighted at its year end results it had already concluded shipbroking business totalling more than $53 million deliverable over the course of the year as of 1 March, some 77% higher than the year earlier.

Market conditions are also favourable, with the £112 million cap yet to see any impact from the global credit squeeze. ‘Not only does the company benefit from the continued buoyancy of shipping markets but also it is exposed to the whole cycle of a ship’s operating life from construction to operation, to sale and purchase and eventual demolition,’ says Peter Ashworth of house broker Charles Stanley Securities.

Over the past year the company has particularly benefited from strong activity and rates in newbuilding, dry-bulk and offshore chartering. Earlier this year, Braemar acquired Steege Kingston Partnership, a group which provides specialist loss adjusting and other expert services to the energy (oil and gas), marine, power and other related industrial sectors.

At the time of the purchase, chief executive of Braemar, Alan Marsh, said: ‘The skills Steege Kingston possess will sit well alongside our existing technical services businesses, Falconer Bryan, Wavespec and DV Howells, and enable us to offer our clients a broader range of services.’

Charles Stanley’s Ashworth is forecasting pre-tax a 5% rise in pre-tax profits to £15.5 million for the year ending February 2009, which leaves the stock on a prospective PE of just above ten times.

James Fisher and Sons 558p, BUY

Old school success

Solid earnings and dividend growth should boost shares in Fisher, which was originally founded in 1847 in Barrow-in-Furness to provide ships to transport iron-rich haematite from the Cumbrian hills to support the Industrial Revolution.

By the 1870s, Fishers was the largest coasting fleet in the UK and has continued to expand ever since. The company is now split into three areas – offshore oil, shipping services and defence. Despite a more uncertain economic outlook, chairman Tim Harris believes the company is well placed, with its main markets remaining strong.

The company has a proven track record of generating cash, good long-term relationships and credit lines with its banks and healthy margins on its bank covenants. Going forward, Harris says the group will continue to look out for bolt-on acquisitions, as well as continue to generate organic growth. James Fisher posted a 54% increase in revenues and a 21% hike in pre-tax income last year and for 2008, consensus forecasts call for further sales and profit growth of 7% and 19% respectively. Fisher’s dividend has grown from 6.67p to 11.41p over the last five years and further increases are forecast for this year and next.

Wincanton 289.5p, BUY

Supplies the goods

A sensible acquisition strategy, a turnaround of an underperforming unit and EU waste recycling directives should drive profits growth at Wincanton. The firm designs and delivers advanced supply chain solutions and has continued to grow organically and through acquisitions.

Over the past year or so, the group has bought four new businesses – Swales Haulage and Hanbury Davies in the UK and Ireland, HeBo in Germany, and UK-based PSHL. Its most recent acquisition opportunity fell through, however, after Wincanton concluded that it was not in the best interests of its shareholders to proceed with an offer for TDG.

Wincanton has a strong portfolio of customers across Europe, including GlaxoSmithKline, BAT, Tesco, Waitrose and Unilever. Wincanton was also the first company in the UK to open a dedicated WEEE (waste electrical and electronic equipment) treatment plant, opening a facility in Billingham, Teesside in March 2006. One weak spot is the £351 million cap’s German business, which is loss making despite generating annual sales of £200 million. A new management team has been appointed and a turnaround programme is under way. Improved performance should be achievable within the next 18 to 24 months. Analysts at Dresdner Kleinwort have a 520p price target on the stock.

Dart Group 15p, SELL

Unattractive package

Even though Dart’s shares have plunged by 90% to 15p in the past 18 months, the shares should still be avoided, as high fuel bills continue to plague its airline customer base.

The group’s distribution business Fowler Welch-Coolchain primarily provides an integrated supply chain solution to supermarkets and their suppliers, food manufacturers, growers and importers. Services provided include both chilled and ambient storage and distribution together with value-added and pick-to-order warehousing operations.

The business continues to grow in a competitive market, but Dart’s overall performance has consistently been held back by its aviation division. Early last year, Dart launched jet2holidays.com to offer customers real-time market rate prices for package holidays, the components of which include low-cost jet2.com flights in addition to accommodation and transfers. Dart believes this operation will make a significant contribution to the airline’s passenger numbers, as well as offering packages with flights from other carriers.

Although jet2.com has increased its services, February saw Dart warn winter trading in its aviation business had not met expectations, as forecast growth in passenger volumes had failed to materialise. As a result of lower yield and load factors, the company’s winter revenue expectations fell by 6% with a ‘consequential reduction in the group’s expected pre-tax profits for the year’. With issues such as high fuel costs continuing to dog the airline sector, Dart may be faced with further problems and the stock remains high risk.

Northgate 362p, SELL

Hire or lower

The UK and Spain’s largest van rental operator share price has crashed by 70% since the start of 2007 and there could be more bad news to come. When year-end results were published at the start of this month (1 July), Northgate warned weaker conditions in the used vehicle market would mean overall pre-tax profits for the current year are expected to come in roughly flat against last year’s £79.5 million.

The company faces tough competition, although it reasons it has so far managed to retain hire business without discounting prices heavily. A bigger problem are the £266 million cap’s Spanish operations where the company generates 47% of its revenues from customers in the construction industry. While the majority of customers are focused on infrastructure projects funded by central government and EU funds with reasonable forward visibility, the company admits vehicles could be returned if demand fell significantly.

If the downturn became more widespread, it would aim to maintain utilisation rates at 90% through decreasing or stopping vehicle purchases, and increasing disposals. Such a plan would preserve cashflow and reduce debt but would hit earnings and forecasts of a mere 11% drop in EPS this year and 3% next look too optimistic.

Autologic 44.8p, SELL

Stuck in reverse

A new management team and a fresh business approach are designed to put Autologic on the road to recovery but difficult conditions in the car industry mean the turnaround may not be easy to effect. Autologic provides logistics services to the automotive industry and specialises in new vehicle preparation, enhancement, distribution and used vehicle refurbishment. Revenues took a severe knock after the loss of an exclusive deal with Ford last November. January saw the £27.7 million cap stock issue a profit warning, citing not only the Ford setback but a deterioration in the macro-economic environment. Pre-tax losses were reduced last year, from £2.8 million to £1.7 million, but progress in 2008 will now be less than previously hoped. Consensus forecasts expect a profit of £3 million but management also warned of a cash outflow of £11 million for the year due to exceptional charges and commitments associated to the Ford deal. Car makers’ share prices have collapsed this year and despite a rally this month after interim results from Fiat and Peugeot were better than feared, it is hard to see how Autologic can prove immune to the blows of rising fuel prices and lower consumer demand. Chairman Reg Heath, chief executive Avril Palmer-Baunack and new finance director Andrew Somerville are all recent appointments but investors should wait until details of the new strategic review have emerged.

SPOTLIGHT

Business Post sends right signals

Chief executive Guy Buswell is shaking things up at the troubled group

Business Post has had its fair share of ups and downs, not least in 2005 when the group issued a series of profit warnings. But the appointment of Guy Buswell as chief executive in December of that year has inspired a turnaround. Investors should cast aside any prejudices formed three years ago and take a closer look.

Buswell originally joined the group in 1989 and was appointed sales director in 1992. After a period elsewhere in the industry, he rejoined Business Post in 1997 and was appointed to the board in 1998. In 2002 he became managing director of UK Mail and took the top job three years later.

Under Buswell’s guidance, Business Post has worked hard to address the underperforming franchise operations in its parcels business and has made solid progress in improving the efficiency and effectiveness of this division.

This prompted an 80-basis point increase in the group operating margin to 8.6% for the year ending 31 March 2008. A new network operations director was appointed in December 2007 and Business Post has restructured the division’s management to improve both operational performance and customer service levels.

The UK Mail division continues to perform well, and new business wins boosted the unit’s sales by 52% to £137.3 million last year. New customers included MBNA and Virgin Media, and UK Mail also won further business from existing customers, renewing a number of major contracts.

Integrated success

Buswell says Business Post is now an integrated business, which he believes it was not before. ‘The managers of each division work alongside each other,’ he adds.

The chief executive’s work is not yet complete, though. Buswell has laid down a target of a 10% operating margin for the parcels business. It is well on the way but there is still more to do. He also wants to capture more of the mail market.

Business Post handles up to 12 million items per day and 11% of all mail is collected by UK Mail. Buswell wants these figures to rise and three new products are to be launched with this goal in mind.

The first of these is ‘iMail’, a next day mail service which allows customers of any size to electronically transmit mail items to the group's national network of mail centres. At these centres the mail is printed, enveloped and sent for next day delivery. ‘This is the first time someone can use an operator other than Royal Mail to send next day mail,’ says Buswell. In addition, it is ‘super green’, estimated to reduce the ‘carbon footprint’ of a letter by 80%. The service is highly practical as it can be used up to 6pm in the evening and even if someone were to use the service on a Sunday, the mail would still be received on the Monday.

In addition, the group is launching ‘disguised mail’ and ‘returned mail’. Disguised mail allows certain mail, such as a credit cards or SIM cards, to be re-enveloped and thus ‘disguised’ to fool thieves, while returned mail is sent back to UK Mail, rather than the customer.

Specialist revamp

Specialist Services also requires further action. The unit reported a 35% reduction in operating profit last year, due to lower revenues in its Courier business. Last March saw the appointment of a new management team and the division’s renewed strategy is to develop a nationwide network of couriers so it can win and effectively support national courier contracts. Early benefits of this strategy have included a new contract from Orange.

Business Post’s balance sheet is ungeared, which is a blessing when credit is less freely available and more expensive, and its biggest challenge is rising fuel costs. The company has thus far successfully passed the additional costs on to customers, but Buswell says the group is now entering ‘unchartered territory’. ‘It is not a problem yet,’ he says, ‘but we wonder what will happen.’ Despite this uncertainty, brokers Dresdner Kleinwort believes Business Post can increase pre-tax income by 27% in 2009 and 22% in 2010, even after last year’s 45% increase.

CONCLUSION: BUSINESS POST 297.5p

Risks to earnings forecasts: 4 (5=upside risk, 1=downside risk)

Earnings predictability: 3 (5=very high, 1=very low)

Valuations: 3 (5=cheap, 1=expensive)

Balance sheet strength: 4 (5=cash rich, 1=heavily indebted)

Cash flow: 3 (5=very strong, 1=very weak)

Over-owned? 1 (5=all brokers negative, 1=all positive)

TOTAL 18 / 30

RATING: BUY

TREND SPOTTING

Overdue rally

After peaking before the wider market, could the sector also bounce back sooner?

by Simon Griffin

Using the FTSE 350 sector index as a yardstick, the sector outstripped the benchmark indices trebling from 2003’s market lows, but lost momentum in late 2006, before the wider market started to swoon last summer.

Industrial Transportation has since lost over half its value, moving more violently than the FTSE 100 or 350. Since mid-May alone, the sector index has lost over 34% of its value. The chart has yet to encourage stale holders or proactive bulls; the trend is still down.

There may just be a case for a tentative contrarian long position. The sector peaked ahead of the market in 2006, so early recovery might be expected. Also, selling has tested 78.6% Fibonacci retracement of the 2003-07 bull market move, just below 2,000. This is the last support that can prevent a full retracement to 2003 lows and the shape of the index move suggests a ‘V’ bottom could be working through. Lastly, the index has deviated from its 200-day average and a correction seems overdue. The interaction of the two moving averages I favour has called the sector turns and it will be some time before they are likely to cross and give a positive signal.

But a move up to test the bear channel return line and 50-day average near 2,480 seems possible, with the bear channel top and 200-day average likely then to combine for resistance near 2,900, if the upmove builds momentum.

FirstGroup (FGP)

BUY - 540p

TARGET - 700p

STOP LOSS - 488p

The transport operator’s shares bucked the sector trend, rising in 2007 and peaking in December at 825p, testing the long-run bull channel top.

Quite a tight bull channel characterised the move up from 317p in November 2005, with symmetry on brief breakouts above the return line and below the base line. After early 2008, the spike down to 560p was too much and the brief recovery to test the channel baseline was an opportunity for sluggish bears to sell. The sell-off saw the shares drop to test coincidence of the 50% retracement of the 2003 to 2007 upmove and the bull trend line drawn off the 2003 and 2005 lows.

This combination seems to have ended the selling near 509p, also the level of the old, significant high seen in 1998. The trend appears to have saucered into a base, at least for the short term.

Very recent price action also suggests a bull flag pointing to further gains, which will test congestion near 620p, a level also likely to be the 200-day average. Moves above this would have the potential to test 700p. Only weakness that drove the shares below 490p would open the possibility of further selling and test the long-run bull trendline, currently pencilled in close to 400p, again a level that has been very influential in the past.

Go-Ahead Group (GOG)

BUY - £17.10

TARGET - £23.40

STOP LOSS - £15.20

The shares have traded in a super long-term bull channel on the log scale chart since basing at 110p in 1994. The past four years saw resistance from the upper channel return line and support from the mid-line – until 2007, when having stalled out on the return line it became clear a complex top formation was developing.

It took until mid-January this year for the neckline of what might be seen as a triple top or possibly a stunted head-&-shoulders to give way at £23.40. This pointed to a move toward £18.25. The shares tested the channel base line at £14.60 and briefly tested £14.00 on a spike low. The channel base line seems to have ended the selling and produced in turn a double bottom pattern, its neckline broken as the shares rose toward a test of the 200-day average. The neckline is now tested for support, not uncommon, and provided the shares stay above £16.90, they can test £20.30 by way of the 200-day average, currently near £20.00. Longer term, a move up to test the channel mid-line and the old top neckline at £23.40 is favoured. Only further weakness, with slippage below £15.20 would concern.

So the sector looks overdue for a bounce, but it is too early to say it will be more than a correction. Should the sector index hold above 1,990 the bottom of the bear move may have been seen.