Fool's Eye View

[ February 21, 2000 ]

Will Exel live up to its name?

By Stuart Watson (TMFTiger)

Great Titchfield Street, London -- As well as direct investment in Internet companies, many Fools on the boards have been discussing investments in industries that may piggyback on the growth opportunities that the Internet provides. One such industry is the logistics business. After all, who is going to deliver all those products you order from your PC or interactive TV?

One group that may fall into this category is Exel, a new company created today by the merger of NFC (LSE: NFC) and Ocean Group (LSE: OGP). Ocean specialises in the air freight side of the distribution business, whereas NFC (which currently owns the Exel brand) is more involved in land-based supply chain management -- or, to put it another way, trucking. Both these businesses are seeing reasonable growth at the moment, as companies concentrate on their core specialties and outsource peripheral operations. Exel already counts two-thirds of the world's largest 250 companies as its customers but expects this trend to continue.

In fact the merger announcement says that the global logistics business will grow by 10% to 20% per annum. Hang on a minute. I don't think I have ever seen such a broad range. Over five years this means the industry will grow somewhere between 60% and 150%. As an investor I don't find that particularly helpful. What would be helpful is to know why this range is so broad.

The new combination will have sales of £3.5b and operating profits of £176m. So go the headlines, anyway. If you look through the announcement in a little more detail then the picture becomes less encouraging. The headline figures suggest an operating margin of 5%. For a price-competitive business like logistics that is not too shabby. It is a tough old business in which decent profitability can depend on making sure your planes and trucks are always as full as possible.

But included within the profits of £176m is £31m in respect of a SSAP 24 pension credit. Jargon alert! Even having trained as an accountant I still find these terms difficult to interpret from an investing viewpoint. In English, this means that almost 20% of the company's profits come from surpluses that have been built up within its pension funds and have nothing to do with the underlying operating performance of the business. If we want to examine the business on a long-term basis we need to strip this figure out, as it does not represent an actual cash flow. If we do so the operating margins fall to 4%, which is considerably less attractive. On the plus side, the group sees potential for £15m in cost savings, which redresses the balance somewhat.

Nevertheless, the market seems to have welcomed the move. The combined market values of the two businesses have risen some 16% today to £3.2b. Both businesses have some debt as well, meaning that the total package is now trading at around 30 times earnings, even including the merger benefits. Now if we only knew whether the business was set to grow at 10% or 20%, we might be able to draw some conclusions.

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