QUALIPORT
A Safe Haven In A Stormy Market

By Maynard Paton (TMFMayn)
October 3, 2002

Associated British Ports (LSE: ABP) is a safe haven in a stormy stock market. As highlighted last week, port owners like ABP are great for long-term investors who seek stability and predictability. For instance, the last ten years has seen ABP consistently produce operating margins of around 40% and improve its dividend by an average of 13% per annum. The company is certainly Qualiport material.

The business

ABP is the UK's leading ports group. It operates 21 domestic ports and handles approximately a quarter of the country's seaborne trade. ABP's ports are located at: Ayr, Barrow, Barry, Cardiff, Fleetwood, Garston, Goole, Grimsby, Hull, Immingham, Ipswich, King's Lynn, Lowestoft, Newport, Plymouth, Port Talbot, Silloth, Southampton, Swansea, Teignmouth and Troon.

ABP was given control of 19 state-owned ports in 1981 and was privatised by the Government in 1983. The subsequent abolition of the National Dock Labour Scheme and the resultant productivity improvements did wonders for the company -- operating profits tripled between the mid-1980s and mid-1990s.

Although the rate of improvement has slowed dramatically in recent years, ports remain generators of steady and predictable profits, with many competitive restrictions providing a 'franchise' feel to their businesses. Read more.

ABP's revenues are mainly earned from ships' dues and wharfage, dredging, stevedoring (cargo handling), the provision of various port services and facilities (e.g. cranes, storage and electricity), property income from port estate tenants, and pilotage and conservancy. Other revenues come from non-port property, an area that ABP is slowly winding down.

The financials

ABP has made steady progress over the past five years.

Year to December 31st      1997    1998    1999    2000    2001

Turnover (£m)             286.9   339.1   351.1   390.6   405.4
Operating Profit (£m)     137.3   150.2   157.4   168.4   170.1
Pre-tax Profit (£m)        99.0   112.6    36.6   139.7   131.0

Earnings per share* (p)    20.8    22.4    24.6    27.5    29.4
Dividend per share (p)      9.0    10.3    11.5    12.8    13.8

(*excluding exceptional items)

Since 1997, improved and additional handling facilities have helped operating profits from port-related businesses increase from £111m to £141m. Over the same time, profits from non-port property have doubled to £21m. As highlighted before, margins are obscene in the port industry. During 2001, ABP's UK ports generated sales of £304m and operating profits of £137m -- a 45% margin.

Acquisitions have played only a minor part in the above five-year record. The Port of Ipswich was bought in 1997 for £12m, American Port Services (APS) was bought in 1998 for £109m and various port service businesses have been purchased for £40m. Sad to say in some respects, but all the purchases have made no material impact on group profits. Indeed, buying APS (an operator of car-processing terminals at various US seaports) was a disaster. One year after purchase, ABP wrote-off £80m relating to APS and dispensed with the services of the group's then managing director.

The appointment of Bo Lerenius as chief executive in 1999 has brought a commendable re-focusing to ABP. Various disposals (including extraneous land and property, plus a ferry business) have raised £250m since the start of 2000. The proceeds have been reinvested back into the core port business and have been used to help fund a substantial share buyback.

Cash flow and return on equity

Highlights from ABP's cash flow are shown below:

Year to December 31st      1997    1998    1999    2000    2001

Operating Profit (£m)     137.3   150.2   157.4   168.4   170.1

Change in
  working capital (£m)     (2.3)   (3.0)    7.1     2.6   (11.2)

Depreciation (£m)          15.5    18.8    21.5    23.6    23.7
Net capital
  expenditure (£m)        (92.7)  (28.5)   (0.1)  (13.9)  (60.3)

Holding no stocks and suffering only minor movements in debtors and creditors, ABP has no problems in the working capital department. Capital expenditure, though, is quite difficult to judge. Various property investments and disposals cloud the picture somewhat.

However, the balance sheet shows tangible operating and property assets increasing by just £67m to £1,387m over the five years to December 2001. Over the same timescale, operating profits from these assets improved by an extra £21m -- not a bad return.

Furthermore, the following statement was made within the 2001 annual report: "Non-revenue earning or 'maintenance' capital expenditure will continue to be closely monitored and contained below the group's annual depreciation charge". With the deprecation charge of fellow port operator Clydeport (LSE: CLY) also seen to be a good proxy for maintenance capital spend, it's reasonable to assume ABP is not in need of constant heavy asset expenditure.

In terms of return on equity, ABP provides a decent performance. Over the five years to December 2001, normalised earnings have improved from £72.2m to £98.1m while shareholders' funds have increased from £914m to £1,012m. Add back the £80m write-off relating to the US folly, and the incremental return on equity comes to 14.5% (£25.9m/£178m).

It's worth noting that additional debt has played a part in this reinvestment performance, with net borrowings rising from £390m to £510m over the past five years. However, at 4.6 times, net interest cover is nothing to worry about.

All in all, the fundamental financial attractions of ABP -- high margins, next-to-no working capital and low capex -- imply this is a company that can inherently generate superior returns on reinvested profits.

Summary and valuation

Ports in general have proven to be solid, predictable businesses and ABP is no exception. While volumes of certain cargoes will fluctuate from one year to the next, handling 25% of the country's seaborne trade through 21 different harbours should leave long-term shareholders sleeping easy.

Multi-year contracts with various shipping firms help to underpin the company's revenues -- 50% of this year's turnover was already in the bag at the start of the year. As well as the decent financials, share buy backs, cautious views on acquisitions and a return on investment target of 15%-plus provide further evidence of a shareholder-orientated boardroom.

At 413p, ABP shares trade on a price to earnings ratio of 14.3 and offer a dividend yield of 3.5% on figures for the twelve months ending June 2002. Assuming earnings are reflected as free cash, the shares presently offer a historic free cash flow yield of 7.0%. Demanding a 7.5% free cash flow yield would require a 384p entry price.