Treasure Chest | Feb 17 2014
-Headwinds to global business
-Manufacturing decline weighs
By Eva Brocklehurst
Freight heavyweight Toll Holdings ((TOL)) is in a strong position vis-a-vis the expected improvement in the domestic economy. The more activity, the more the company transports. Toll has also been busy reducing costs in its global freight forwarding business and now drives a lean machine. So why have several brokers voiced concerns about the business, particularly on the global forwarding front?
CIMB Securities is hesitant to recommend the stock. The broker has a Reduce rating and $5.26 price target. CIMB thinks there are enough risks to the outlook to be cautious regarding 2014. A low-growth environment means subdued activity and this should belie any cost cutting efforts. That said, the broker does expect free cash flow to improve and this should deliver a higher dividend. Pressures are coming from competition in global freight forwarding and less activity in the resources industry. To become more confident, the broker would need to see increased consumer activity in the domestic economy. Why is this so important? The company takes 80% of earnings from domestic operations so the economy is a key driver of the outlook. What's positive is that Christmas retail trading was solid and this would have benefited the company. Housing and consumer spending should also remain supportive.
So, where is the niggle? The logistics operating environment has become competitive and CIMB's checks have revealed that many contracts, rather than being rolled over, are being put out to tender on expiry. This puts downward pressure on pricing and margins, as operators face lower top line growth but still experience increased costs. As this trend is likely to continue in 2014 CIMB thinks much will depend on what sort of volume recovery is seen in the broader economy.
JP Morgan recently reviewed the stock and echoed some of these concerns, downgrading to Underweight from Overweight in one fell swoop. The broker expects a flat first half on a constant currency basis and, while the depreciation in the Australian dollar is expected to help, the market may be more keen to focus on the underlying trends. In this aspect, JP Morgan observes Australia's GDP has almost halved since the peak in growth at the beginning of 2012. As manufacturing output closely follows GDP – and is an important indicator for a transport business – it implies weakness for Toll. Another number the broker quotes is container volumes at the main ports. For the five months to November these were up 0.4%, with Melbourne and Sydney each down 2.6% – not a good look.
Essentially, the broker fears disappointment and has recommended taking profits in the lead up to the results. JP Morgan expects domestic divisions to perform relatively well and thinks the main issues are with global forwarding. Moreover, the market may like to see action on the disposal of underperforming business and as this has been slow to materialise the broker is hoping for an update on targets and strategy.
CIMB thinks global freight forwarding will be a continued drag on earnings and, while management has been trying to position the business appropriately, it remains sub scale. In the interim results, due on February 19, CIMB will be looking for the cost cutting benefit from the first half and whether margins have withstood the mounting pressure. Also cash conversion was weak in the prior corresponding half and the broker will be wanting see if the company has addressed the issues on that front.
Those in the more neutral camp, albeit without recent updates on the stock, such as Citi, UBS and Credit Suisse, also think there's mounting challenges. Citi expects volumes to recover but considers this is factored into the share price already. UBS has been concerned about gradual margin declines in Toll's parcel express division while Credit Suisse thinks global forwarding is running into headwinds but likes the attractive cash flow. Deutsche Bank is the one broker on the database that retains a Buy rating.
The stock has four Sell ratings, three Hold and one Buy on the FNArena database. The price targets range from $5.00 to $6.10 (Deutsche Bank). The consensus target is $5.45, which suggests 3.5% downside to the last share price. Toll has a consensus dividend yield of 5.0% for FY14 on the database and 5.3% for FY15.
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