QUALIPORT
Plain Sailing In A Choppy Market

By Maynard Paton (TMFMayn)
February 20, 2003

Associated British Ports (LSE: ABP) has all the hallmarks of a Qualiport business: an obvious moat, a proven record and great cash flow. Preliminary results on Wednesday confirmed ABP's dependable nature, with solid improvements registered in sales, profits and the dividend.

For those readers wanting a fresher on ABP, this article gives some background to the UK port industry while this article reviews the company's financial history.

Results 2002

The table below shows ABP's financial performance:

Year to December 31st      1998    1999    2000    2001    2002

Turnover (£m)             339.1   351.1   390.6   405.4   429.8
Operating Profit (£m)     150.2   157.4   168.4   170.1   175.8
Pre-tax Profit (£m)       112.6    36.6   139.7   131.0   140.5

Earnings per share* (p)    22.4    24.6    27.5    28.1   30.4p
Dividend per share (p)     10.3    11.5    12.8    13.8   14.8p

(*excluding exceptional items)

On a continuing basis, turnover for 2002 jumped 7% to £402m while operating profits improved 3% to £172m. A lower interest charge and the effects of a share buyback helped underlying earnings per share gain 8% to 30.4p. The full-year dividend increased 7% to 14.75p per share.

The UK ports business, which generates over 80% of group revenues and income, put in a sturdy performance. Various new developments, such as a £6m rail siding at Immingham and a £4m vehicle terminal at Southampton, bolstered the division's turnover by 7% (to £326m) and operating profits by 3% (to £141m). (And yes, the operating margin is an amazing 43%.) Reassuringly, ABP confirmed that over 50% of its UK ports revenue for the next twelve months was underpinned by contracts.

Elsewhere, ABP's property interests contributed a flat £19m profit, while profits from the group's US operations crept up to £2m.

Other highlights included ABP's debt and an FRS17 update on the company pension fund.

Net borrowings decreased by £59m to £450m, which left interest payments covered a comfortable 4.7 times. On the pension front, ABP revealed a year-end pension surplus of £34m, some £70m below that reported twelve months earlier. The company closed its defined benefit scheme to new entrants in April.

Cash flow

The 2002 performance emphasised ABP's great cash flow characteristics:

Year to December 31st      1998    1999    2000    2001    2002

Operating Profit (£m)     150.2   157.4   168.4   170.1   175.8

Change in
  working capital (£m)     (3.0)    7.1     2.6   (11.2)    3.3

Depreciation (£m)           18.8    21.5    23.6    23.7   24.5
Net capital
  expenditure (£m)        (28.5)   (0.1)  (13.9)  (60.3)  (73.3)

Holding no stocks and suffering only minor movements in debtors and creditors, ABP has no problem whatsoever in the working capital department.

Various property investments and disposals cloud the general capital expenditure picture, though. However, ABP commendably made this remark in Wednesday's results: "During 2002, maintenance expenditure was just below the level of depreciation and it is the group's aim that this will also be the case in 2003. In contrast, the only restriction the group places on revenue earning capital projects is that it targets at least a 15.0 per cent internal rate of return on these projects, and the group does not enter into major speculative investments."

Overall, it's fair to say accounting earnings are a genuine proxy for free cash. However, it's worth realising ABP capitalises (rather than expensing through the profit and loss account) certain, significant costs.

Over the past few years, the company has paid £35m (of which £11m was spent during 2002) to develop a deep-sea container port at Dibden, near Southampton, the final go-ahead for which rests with the Government. A decision is expected late this year or 2004; if it's unfavourable, expect profits to incur a £35m write-off.

Return on equity

Although ABP has low working capital and maintenance expenditure requirements, the company's asset-light nature is not reflected in the incremental return on equity calculation.

There are two reasons. Firstly, a disastrous foray into the US caused all sorts of exceptional write-offs in 1999. Secondly, ABP sits on plenty of prized property, which generally rises in value over time. When revaluations take place, shareholders' equity expands without a commensurate increase in profits.

For the record, recent returns on equity come to about 10%. Not great, but on balance, the fundamental accounting attractions -- high margins, next-to-no working capital and low capex -- imply ABP can inherently generate superior returns on reinvested profits.

Summary & valuation

Boosted by their obvious franchises, ports in general have long proven to be solid, reliable businesses. Profit growth isn't spectacular, but as ABP's latest results show, they're dependable during tricky economic times.

In general, everything remains in order at the UK's largest port operator. Great cash flow, long-term contracts and no great reliance on one particular cargo is all good news for prospective shareholders. Contrary to other port operators, ABP's continuing disposal of non-port property should also buoy shareholders who like their boardrooms to have operational focus.

At 400p, ABP shares trade on a price to earnings ratio of 13.2 and offer a dividend yield of 3.7% based on the 2002 figures. Assuming earnings are reflected as free cash and adjusting for discontinued businesses and a standard 30% tax rate, the shares presently offer a historic free cash flow yield of 7.2%. Demanding a 7.5% free cash flow yield would require a 384p entry price.

More: Big Fat Profits From Quality Port | A Safe Haven In A Stormy Market | ABP Discussion Board