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Should You Buy Parcels Firm DX (Group) PLC As It Acquires City Link Assets?

The boom in online shopping ought to be good news for the parcel delivery sector, but as the Christmas Day collapse of City Link showed, this sector has two big problems.

Firstly, retail customers want fast, tracked and timed deliveries, but they don’t want to pay for them. Secondly, there’s too much capacity in the parcel delivery sector.

As a result, many parcel delivery firms are slashing their rates in order to win new business. Inevitably, some companies will go under — but I think I may have found a profitable opportunity in this cut-throat sector.

A 7% yield from parcels?

A race to the bottom on low-value parcel delivery isn’t the only way to operate: parcel and mail delivery firm DX Group (LSE: DX) is taking a different approach.

AIM-listed DX, which announced this morning that it has purchased some of City Link’s assets for £1.125m, was founded by industry veteran Petar Cvetkovic, who previously ran Target Express and then City Link, after it merged with Target in 2007.

Rather than chasing low margin retail business, DX is focusing on areas where it can add value and justify stronger pricing. Examples include next day delivery of time-sensitive, high-value items and two-man deliveries to both business and retail customers.

DX shares have suffered from the market downturn, and the firm’s share price is down by 33% since its IPO in February 2014.

The company’s outlook has remained stable, however, leaving DX shares on a forecast P/E of 7.5 and with a chunky 7% prospective yield.

A closer look

I do have some concerns about DX’s balance sheet, which has negative assets once goodwill and intangible assets are stripped out, but apart from this the figures look attractive.

Last year, DX reported an underlying operating profit margin of 8.7% on sales of £312m, and generated free cash flow of around £17m — about 8.8p per share.

DX has minimal debt and its value-added strategy should help it maintain pricing power over its peers. If the firm can deliver a repeat of last year’s performance this year, then the forecast 6p dividend isn’t unrealistic, giving a 7% prospective yield at today’s share price.

31% upside?

If DX can deliver reliable profits, I believe the firm’s shares could re-rate onto a P/E of around 10. Based on forecast earnings per share of 11.4p, this suggests 31% upside to the current share price, in addition to the generous 7% yield.

As a result, I reckon that DX could be an interesting buying opportunity in today’s market.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.