Singapore Post Ltd (SPOST SP) - Maybank Kim Eng 2016-09-20: Gain after Pain; U/G to BUY

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SINGAPORE POST LIMITED S08.SI

Singapore Post Ltd (SPOST SP) - Gain after Pain; U/G to BUY

Issues on the mend, Board revamped; TP raised 37% 

• Three of our key concerns on the stock earlier are gradually being addressed: 
  1. corporate governance issues appear to be fading with a partial revamp of the Board of Directors and SingPost taking on board various recommendations of the recently concluded audits; 
  2. significantly reduced risk of more big-ticket (and likely ROIC dilutive) acquisitions that were pursued by the previous leadership with the focus shifting to integration and monetization; 
  3. the stock has fallen c.13% YTD and growth expectations have been reset to more reasonable levels with consensus forecasts cut by > 10%. 
• We raise our DCF-based TP 37% to SGD1.77 from a drop in our WACC estimate from 11.3% to 8.7% to reflect much lower new acquisition and execution risk, and upward revisions to our medium-term profit growth outlook. 
• Upgrade to BUY from SELL.

House cleaning underway 

• Since the resignation of CEO Dr. Wolfgang Baier in Dec 2015, SingPost went through a rough cleansing period. Its share price has fallen by 13% YTD and 9% since Jun 2016. Shortly after the CEO left, several corporate governance issues unravelled. As a result, the chairman, two directors and the COO resigned.
• Nonetheless, we have seen changes and positive actions taken since Mr. Simon Israel stepped in as the new chairman in May 2016: 
  1. The risk of burning cash in value-destroying acquisitions has fallen, as the new board is committed to integrating previous acquisitions and expanding the core business. Its collaboration with Post Luxembourg in Aug 2016 is a good example for SingPost to leverage on its postal network strength and more importantly, this deal does not require major investments.
  2. The dividend policy has been placed under review to ensure sustainability; as mentioned the revised dividend policy should be tied to core earnings.
  3. Clear separation of duties between the board and management has been put in place. We note that the new chairman interferes very little in the management duties. Also, SingPost has adopted a new policy to ensure that directors do not serve more than six years to ensure independence. Since its IPO, CEO departure has been frequent and none of them made it past the five-year mark. The revamped board should allow the incoming CEO to focus on execution and effect changes without interference.
• We believe the aforementioned measures will create a supportive platform for the new CEO to grow the core business and effect changes as deemed necessary.
• SingPost expects to have its new CEO on board by the end of 2016. As the company has gone through a slew of acquisitions in the past couple of years under the previous senior management team, many of whom had consulting, M&A-related backgrounds, we believe the ideal candidate for the company at the current juncture would be someone with a strong operational background able to drive integration, execution and monetisation.
• We expect a more focused strategy to build SingPost’s core mail and regional logistics capability. Also, a review of assets is likely to identify non-core assets for divestment (for example, it sold its self-storage business in Japan in Sept 2016).

Alibaba and Lazada positives; volumes are growing 

• The discussion with Alibaba on its second investment in SingPost is progressing – we understand given various business opportunities arising from related investments, both parties are working to finalise the joint venture agreement.
• To recap, the long-stop date has been extended three times and the next one falls on 31 Oct 2016. Management attributed some of the delay to Alibaba’s acquisition of Lazada and SingPost’s purchase of TradeGlobal.
• In our view, the negotiations could also have been disrupted by the various board member and senior management changes at Singpost.
• Since the announcement of Alibaba’s second investment in May 2014, SingPost’s CEO, COO, chairman and two directors have left the company.
• Importantly, Alibaba’s volumes are still growing consistently and this demonstrates its operational commitment in partnering with SingPost in our view. Alibaba’s volumes are mostly captured under SingPost’s international-mail revenue. The deliveries pass through Singapore either destined for the end domestic market or as a transhipment hub for third-country destinations such as Indonesia (or rest of ASEAN) where parcel volumes have not reached a viable economic scale to warrant direct shipping to the end destination country. We believe there is room for SingPost’s international mail volume to expand further, with greater penetration of Alibaba’s Singles Day sales outside of China and global tractions on its e-commerce platforms.

Lazada a sweetener, not a threat 

• Management clarified that Alibaba’s acquisition of Lazada is unlikely to jeopardise SingPost’s businesses with Alibaba. In fact, two tri-partite meetings have been carried out to discuss potential collaborations. We understand Lazada’s priority is to expand its online marketplace platform and logistics will be outsourced to cost-efficient and reliable third-party providers. We discovered Lazada has been partnering with many established logistics providers in each market.
• Its in-house LazadaExpress should target areas with poor logistics access and third-party operators have been running the operation under Lazada’s brand name. Furthermore, given Lazada’s rapid growth in gross merchandise value, its in-house logistics capability might not be able to keep up. In the 2015 annual report, Rocket Internet highlighted that Lazada has expanded its logistics capabilities to accommodate its rapid growth and to address logistics challenges in the region. Lazada’s fulfilment network included 10 fulfilment centres across Southeast Asia and the company’s last-mile unit, Lazada Express, reached more than 65% of its customers, covering 250 cities and districts with 84 last-mile distribution hubs, six sortation centres and a fleet of over 2,000 vehicles.
• SingPost could benefit from increased volume from more Lazada collaboration with Alibaba, to enable local retailers to sell their products across each other’s platform. To help merchants and retailers boost their sales, Lazada will conduct an online festival from Nov to Dec. It expects sales volume at this year's event to be 3-5x higher than last year. If this takes off, increased outbound China deliveries could boost SingPost’s international revenue.

Dividend policy review to reflect changing business model and for sustainability 

• As mentioned, SingPost’s board has placed the dividend policy under review. We expect the new policy to be a payout ratio tied to core earnings. This should ensure sustainability and it’s more suitable to reflect the changing business model, which could be more correlated to e-commerce consumption.
• This could mean better growth prospects as SingPost transforms from a utility-like company to a consumption company. On the flip side, earnings could be more volatile as growth might be affected by fluctuations in consumption due to the economic environment.
• To ensure sustainability, the new dividend policy might set a payout ratio of 80-90% of core earnings. We trimmed our FY17E dividend to SGD6.25cts in anticipation of the new dividend policy, indicating a payout ratio of 88% and dividend yield of 4.4%. For FY18E, we maintain SGD7.00cts dividend forecast, which indicates a payout ratio of 87% and dividend yield of 4.9%.
• Operating cash flows remain robust from the steadily growing mail business. Also, we note that FY17 will be the peak capex cycle for SingPost as two major projects will take place: 
  1. the regional logistics hub; and 
  2. the e-commerce retail mall. 
• With the logistics hub set to be completed in 3QFY17 and the e-commerce retail mall in 1QFY18, capex should decline significantly from FY18 onwards.
• More importantly, SingPost has committed to focus on growing the existing core business and it will stop pursuing mega M&As. Also, it might divest more non-core assets.

Falling execution, investment risk warrants upgrade 

• We believe the share price weakness (-13% YTD and -9% since Jun 2016) has priced in risks of assets impairment and the Street’s earnings expectations have been reduced by 10% since Jun 2016.
• Upgrade to BUY and DCF-based TP raised 37% to SGD1.77, after:
  • Reducing our WACC to 8.7% from 11.3% to reflect a lower risks profile;
  • Raised our cash-cow phase growth assumption to 2.0% from 1.5% to reflect the higher growth prospects from SingPost’s renewed focus in growing the core mail business.
• Key risks to our upgrade and positive thesis are failure to capture increasing Alibaba volume as this will be the major earnings driver, and significant write down of investments.

Swing Factors

Upside

• Faster than expected turnaround of TradeGlobal, a newly acquired e-commerce enabler for fashion and lifestyle.
• Higher than expected revenue growth in e-commerce logistics, from more customers and services.
• Higher than expected margins for e-commerce logistics, from economies of scale and operating leverage.

Downside

• Inability to resolve corporate-governance conundrum, including board’s independence and disclosures.
• Failure to extract synergies and integrate its largest acquisition, TradeGlobal.
• Worse-than-expected deterioration in mail business before e-commerce logistics compensates.

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-09-20

Maybank Kim Eng SGX Stock Analyst Report BUY Upgrade SELL 1.77 Up 1.290