QUALIPORT
Converting Coal Into Cash

By Maynard Paton (TMFMayn)
August 22, 2002

Clydeport (LSE: CLY) is a fine business. Although rather unglamorous, the company clearly demonstrates how owning a handful of ports can be a steady and very profitable activity. But at 421p, it's not obvious that investors should step aboard the shares just yet.

Quay features

Clydeport owns and operates four ports on Scotland's west coast. The company's activities encompass an area of approximately 450 square miles on the River Clyde, its estuary and nearby sea lochs.

Clydeport's history can be traced back to 1966 when the Clyde Navigation Trust, the Greenock Harbour Trust and the Clyde Lighthouses Trust all merged to form the Clyde Port Authority. The Authority, owner of Glasgow, Greenock and Androssan ports, was privatised in 1992 and was subject to a management buyout soon after. Clydeport purchased the neighbouring port of Hunterston in 1993 and floated on the stock exchange in 1994.

Clydeport's activities can be divided into three parts:

* Hunterston: This deepwater terminal has supported Clydeport's growth in recent years. The port focuses primarily on coal imports and, with 10% of the market, is now the UK's largest in volume terms. Hunterston has seen coal tonnage rise from 1.1m in 1996 to 4.9m in 2001 and handles over 50% of the group's imports.

* Other ports: The port of Glasgow handles a wide variety of bulk commodities (e.g. maize, grain, soya and road salt). Greenock Ocean Terminal primarily processes container traffic, forest products and cruise vessels, while Ardrossan operates a roll-on roll-off ferry port.

* Property: Clydeport owns a variety of property developments adjacent to its port operations. Rental income is generated via the letting of offices and industrial units. The company is also involved in a number of property joint ventures, whereby the company (occasionally) adds to, prepares and sells off (or leases) parts of its land estate. Covering 120-acres on the bank of the Clyde, Glasgow Harbour is the major development currently on the go. The project, a 50:50 joint venture with Bank of Scotland, has a forecast value on completion of £450m.

Taking a long-term business perspective, Clydeport appears to be an attractive operation. Owning a port does bring with it a few inherent competitive advantages. Physical, geographical and planning restrictions mean a rival operator can't just set up shop next door. Indeed, Hunterston is one of only five ports in the UK (and the only one in Scotland) that handles coal imports in any sizeable volume.

That said, importers do dock elsewhere if there are problems. During 2000, Hunterston's tonnage fell 25% as difficulties occurred in the coal's onward rail transportation. Longer term, Clydeport points to the increasing use of foreign low sulphur coal and static-at-best domestic production for greater import volumes. Furthermore, visibility of earnings is supported by "significant guaranteed minimum tonnage commitments for up to three years" from key coal importers (e.g. Scottish Power (LSE: SPW)).

The financials

Here is Clydeport's five-year record:

Year to December 31st        1997     1998    1999     2000     2001

Turnover (£m)                20.6     26.3    30.4     34.2     41.4
Operating profit (£m)         7.5      9.4    11.9     14.0     15.8
Pre-tax profit (£m)           7.8     10.0    12.2     14.1     15.9

Earnings per share (p)       19.0     18.3    20.8     25.3     27.2
Dividend per share (p)        5.5      6.5     7.5      8.6     10.5

Just one minor acquisition (since sold) and no exceptional charges give clarity to Clydeport's five-year performance. However, the adoption of FRS17 for 2001 does cloud recent progress. On a pre-FRS17 basis, operating profits jumped 32% to £17.2m as a rebound in coal tonnage at Hunterston (up 92% to 4.9m) fed through to the bottom line.

Overall in 2001, port activities generated 81% (£33.7m) of group sales and 74% (£13.6m) of group operating profits. Before central costs, the operating margin on the port business has generally fluctuated between 30-40%.

Clydeport's balance sheet contains a few notable highlights. For starters, the company carries net cash of £23.6m (55p per share), has a FRS17 pension surplus of £10.1m ("we do not foresee the resumption of contributions in the near future".) and an after-tax "unrecognised valuation surplus" on non-investment properties (e.g. docks, quays etc.) of £35.6m (84p per share).

Cash flow and ROE

Year to December 31st        1997     1998    1999     2000     2001

Operating profit (£m)         7.5      9.4    11.9     14.0     15.8

Change in
  working capital (£m)        1.6      0.8    (2.5)    (2.5)     2.0

Depreciation (£m)             1.2      1.3     1.3      1.7      1.8
Net capital
  Expenditure (£m)           (4.3)    (1.7)   (7.7)    (3.9)    (2.6)

Clydeport shows no problems with working capital. Over the past five years, 99% of operating profits have been converted straight into cash. On the tangible fixed assets front, Clydeport has commendably detailed the major areas for expenditure over the past three years. Over that time, accumulated deprecation has totalled £4.8m while 'maintenance' expenditure has been around £6.0m.

Although Clydeport owned tangible fixed assets (excluding investment properties) worth £34.6m at December 2001, the company has only spent a net £4.1m since 1996. With profits and sales more than doubling over that time, it's fair to assume Clydeport requires very little capital expenditure for its ongoing activities.

The low reliance on working capital and fixed assets translates into a robust incremental return on equity performance. Since 1996, earnings have increased by £5.9m while the equity base has swelled by £32.5m (both figures adjusted for goodwill and FRS17). The resulting incremental return on equity comes to 17.6%.

Valuation and summary

Clydeport presents a bit of a dilemma. On the one hand, its ports are appealing niche businesses. Although not having the greatest of growth prospects, they're attractive, high margin, cash generative operations. While alternatives do exist, it's fair to say Clydeport (or any other port) has an inherent competitive advantage. Do you import your coal to Scotland via Hunterston, or instead go via Merseyside and face the additional time/costs of onward transport?

And then there's property. While rental income appears steady, profits from development are by no means predictable. As to how much Clydeport will receive from Glasgow Harbour and its other projects (most are only at the planning application stage) -- and over what timeframe -- is anybody's guess. Clydeport generated a £4.4m property development profit in 2001 and while the boardroom hasn't put a foot wrong so far, it's not entirely clear how the skills of running a port cross over to developing sites for property.

With earnings a genuine proxy for free cash, Clydeport's shares (at 421p) offer a free cash flow yield of 6.5%. That calculation excludes a £2m FRS17 pension credit but includes property development profits (which may or may not become a regular income stream in the future). On balance, it appears there's no obvious value in the shares at present. However, the attractive financial characteristics of owning a port are quite clear. As such, an inspection of Forth Ports (LSE: FPT), Associated British Ports (LSE: ABP) and/or Mersey Docks (LSE: MDK) should be in order.

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