Australia | Aug 27 2010
By Greg Peel
The nature of inventory management has changed across the globe in the twenty-first century. Whereas once economic cycles would feature businesses being caught short of stock in the boom times and stuck with overflowing warehouses in the bust times, these days businesses tend to adopt what is often called a “just in time” system. Such a system allows for skinny inventories and rapid response.
The internet is a big factor. Aside from accurate inventory management provided by modern software, the internet allows deliveries to be tracked constantly down to the nearest passing lamp post or cloud and allows rapid communication between buyers and sellers of goods. We are now in what Deutsche Bank describes as a “low inventory world”.
Inventory movements are the lifeblood of transport and logistics companies, so a low inventory world does not sound too encouraging. However, low inventories do not mean fewer sales, just different logistics. Orders need to be smaller and speedier, hence service companies must adapt to the new regime.
Which is exactly what Toll Holdings ((TOL)) has spent FY10 trying to do.
It has cost Toll a good deal of capital expenditure at a time when demand for transport has been weak. Over the past three years we have seen an initial panic destocking phase inspired by the GFC, driven by fear of being caught with unsellable inventory, followed by a rapid restocking phase as global stimulus turned the recession around and shelves needed to be refilled, followed by what has been the feature of 2010 – more destocking. Another destocking phase began because (a) restocking must reach a pinnacle anyway and (b) suddenly Europe and China scared every consumer back into their box.
Everyone of us knows that whenever we have walked into a retail store in the past few months, we are met with discount stickers and everything-must-go sales. That means inventories are being wound down to more manageable levels, not up. Yet analysts were still surprised to see Toll's local divisional earnings drop by a full 21% in the second half of FY10 having already fallen 12% in the first half.
It was this number which jumped out of yesterday's Toll earnings result, once analysts had got passed the headline number. The headline number was in line with forecasts, but the company's effective tax rate had unexpectedly fallen 6% to 20%. So what was wrong? Oh dear – the Australian and New Zealand numbers were pretty pitiful.
Thankfully, a booming Asia meant that Toll's international divisions fired on all cylinders to help offset the loss.
The outlook is still pretty grim, at least for the first half FY11. Both analysts and Toll management agree on this point. But the other point analysts largely agree on is it won't be grim forever, and by the second half we should be seeing a recovery, particularly in beaten down retail sales, which feeds through to transport and logistics demand.
Local stock analysts have not really had a very good track record lately on picking the timing of this so far mythical recovery. But one presumes they must eventually be right. So while out in what for many Australians is simply the fantasy world – that of mining and energy – logistics companies are winning valuable contracts from the likes of the massive Gorgon project, back in the real world (ex-resource) recession, recovery will depend on the retail consumer. Retail consumption is quite simply weak right now, but analysts believe the situation will improve as we head into 2011.
And if they are right, Toll's restructuring for the new low inventory world should prove justified and earnings growth should flow once more. The money has mostly been spent now, so the FY11 capex bill will be a lot lighter. A recovery should play right into Toll's hands.
Five out of ten brokers in the FNArena database are prepared to back this upside, and as such have Buy ratings on Toll. The other five are on Hold citing ongoing short term weakness.
Toll's earnings per share result for FY10 came in at 45c, and consensus has only a jump to 47.4c in FY11 as FNArena's Stock Analysis service notes. But it is FY12 consensus of 54.0c which offers the attraction and reduces implied price/earnings from 12.5x to 11.0x.
A consensus target of $6.70 is 13% above today's traded price. Perhaps analysts might be getting closer to getting this recovery timing issue right. We can only hope.
