DX Group reported earnings today. Few things to note:
Revenues fell 4% to
Net Income fell 86%
Company impaired goodwill (£88.4) and posted a loss of £87.1 million
Excluding goodwill, net income was £1.3 million
Company still intends to pay 2.5 pence dividend, which is about 13% of my purchase price
OneDX is still underway
What I found odd was that the initial price drop where the stock fell 73% on November 13th, 2015 now fully reflects the reality of the company. But how did the November 13th sellers know that profits were going to drop by 80%? My guess is that there was an earnings leak before the Nov earnings, and whoever was the recipient was ready to pull the trigger at any price. DX Exchange was a headwind for the company as management stated that it declined by 10% and the fixed cost nature of the sub-segment was not easily eliminated, that added to the earning woes. Since the segment is declining, I don’t see how there won’t have another episode of this in the future.
The company does not disclose what percent of profits or even revenues DX Exchange accounted for. What I know, however, is that DX Exchange is under the Mail and Packets (M&P) Segment, and in FY 2014, M&P made up 39% of revenues. The M&P also includes DX Secure and DX Mail is more mass market, so likely carries the majority of revenues. What is clear to me is that DX Exchange makes up a small percent of revenues, but a very substantial percentage of the company’s total profits, since management consistently emphasizes this sub-segment. This likely is why the company’s profit margins were much higher than its peers. The 10% drop in DX Exchange revenues still does not explain significant decline in profits, and management has been vague about the profit makeup of the company. I just did not expect the result to warrant the original 80% drop to where I picked up the shares. Although I expected profits to fall by about 50% at best, and not 86%. Also, management’s outlook is:
Despite the current headwinds to the business, and with much to do still in the seasonally important second half, the Board anticipates that the Company will trade over the full year broadly in line with its expectations.
There is no expected recovery in profitability, and the more DX Exchange declines, the worse the fixed cost headwinds will get. Also, the goodwill impairment also hints at a non-performing segment, which is likely DX Exchange. I called the company to confirm that the outlook was based on the November update and not last fiscal year. I subsequently exited my position at an average price of £0.2113 for a total gain of 6.6%. I’m going to keep an eye on DX. They still are in transition to OneDX which management expects to generate £4 million in cash flows starting 2018. Also, if they can curb the fixed costs, we should see some margin expansion. I’m just no longer comfortable holding it at this price knowing what I know now unless I see some notable improvements.
Just Increased my stake in DX Group by 20% at £18.75, average purchase price now sits at £19.81 and Sold 20% of my stake in Game Digital at £1.10. The purpose of this is to reduce my exposure of GMD. Remember I bought some more at an average price of £1.09 in January. Also, Crude is down, and so are world markets. I will be increasing the Reitmans position if it drops today.
Update: Added some Reitman’s at an average price of CAD $3.90
DX (Group) PLC (DX.L) is a leading independent parcel, mail and logistics services company operating throughout the UK and Ireland. DX operates under three segments, and seven sub-segments:
Parcels and Freight (52% of Sales)
DX 1-Man – Specializes in delivering irregular dimension and weight items. 63% of this is Business-To-Business (B2B) although the Business-To-Consumer (B2C) aspect of it is growing as a result of the online shopping trend.
DX Courier – Next day parcel services for the B2B network.
DX 2-Man – B2C home delivery for bulky items (furniture etc.) and furniture assembly, if applicable.
Mail and Packets (39% of Sales)
DX Exchange – Provides an overnight delivery service primarily to customers in the Legal, Financial and Healthcare sectors.
DX Secure – Primarily delivers bank and credit card items and has an exclusive contract for Her Majesty’s Passport Office (HMPO). HMPO provides passports for British Nationals worldwide, and DX delivers those passports across the U.K.
DX Mail – Low cost mail service for smaller volume users.
Logistics (9% of Sales)
DX Logistics – Provides services from basic warehousing, stock management and delivery to customer-liveried vehicles and uniformed personnel.
On November 13th, 2015, DX Group released an update. Management said that Sales for the first four months of FY 2016 are down by 5.3%, the DX Exchange sub-segment is experiencing a higher level of volume erosion than they expected. The volume erosion is being caused by electronic/online alternatives. The stock fell off a cliff.. literally. A staggering 73% drop in one day (Chart 1).
Driver shortages, an industry-wide problem, is also creating cost headwinds for DX. The shortage is a derivative of the aging demographic of U.K. truck drivers; older drivers have been retiring, and the trucking industry has not been able to replace them. According to Milestoneops, a website that advertises and provides staffing services for the Logistics and Transportation Industry, new entrants to the driving workforce have dropped from a record high of 48,227 in 2005 to a low of 25,000 in 2012 – almost a 50% fall. According to a study done by the U.K. Parliament, only 2% of Large Goods Vehicle (LGV) (defined as vehicles weighing 3,500 kg / 7,716 lbs or more) drivers are below the age of 25, 60% of them are above the age of 45. The new European Union Certificate of Professional Competence (CPC) standard for LGV drivers has contributed to the shortage woes. It requires all LGV drivers to obtain the new CPC certification, which requires 35 hours of training and costs upwards of £500. Those that do not get licensed and are caught driving will be fined £1,000. The deadline for this was September 2014. This has created an entry barrier because younger folks that have an interest in the industry have to come up with the exorbitant certification fee, which they most likely do not have, and so they end up doing something else. Also, the aging demographic, are likely to call an early retirement, further crippling an already crippled industry.
The company is rolling out its OneDX integration and development plan. The plan is to consolidate the operations of the three major segments to drive efficiency and cut costs. This includes the acquisition of the site as well as development costs at an estimated total cost of £35 million which will be funded through operating cash flows and the revolving credit facility. The expenditures are expected to drive a conservative £4 million in savings per annum starting 2018.
The outlook on operations is rather bland. The driver shortage woes are likely to continue in the near-term since it is partially the result of an unproductive government regulation. Management already mentioned that Sales, on a comparable basis, were down 5.3% for the first four months. Full year revenues last year came in at £298 million.
Free Cash Flow Machine at current prices
DX Group Generated £27.7 million in Cash Flows From Operations (CFFO) last year. Management does not break down maintenance and growth CapEx, total CapEx came in at £9.9 million, and depreciation came in at £8.4 million. Free cash flow, assuming the higher 9.9 CapEx number came in at £17.7 million. Free Cash Flow of £17.7 million for a company with an Enterprise Value of £41 million or 2.3x EV/FCF ratio is not too shabby. That number does not even include the extra £4 million from the OneDX integration that we expect to see come 2018. With that added in, DX trades at a staggering EV/FCF of 1.89!
Management paid out £0.06 in dividends this calendar year. The dividends were paid when the stock was still trading at the £0.80 – £0.90 range. It trades at £0.20 right now, and those dividends would represent a 30% dividend yield at today’s prices. Management only expects to pay £0.025 in dividends next year, which is still ~12.5%. When the transition to OneDX is over, the dividend payout will most likely increase.
Employee Stock Options
The Company issued about 5.8 million shares or 2.9% of the outstanding shares (200 million outstanding) to management in the form of stock options. The average exercise price for these options is £0.95, or about a 375% upside from the current price. Management has every incentive to get the stock price back to £0.95; otherwise, they’ll never be able to sell them.
DX (Group) PLC
DX clearly trades at a substantial discount to its competitors. 200% upside from current prices would put the EBITDA multiple at 3.75, which is still conservative. DX will make up 7% of my portfolio.