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FedEx Ground Margins Grappling With Wage/Cost Inflation, but Improvement Still Likely

Business Strategy and Outlook

Overnight delivery pioneer FedEx is one of three large national carriers that dominate the for-hire small-parcel delivery landscape–FedEx and UPS are the major U.S. incumbents, while DHL Express leads Europe. Rival UPS has been around much longer in the U.S. ground market, forging a density advantage and higher margins, but FedEx has gradually enhanced its ground positioning over the past decade, with help from its speed advantage over UPS and capacity investment.

Leading up to the pandemic, ground margins were grappling with heavy network investment, the gradual mix shift to lower-margin B2C deliveries, lost Amazon revenue, and a pullback in B2B shipments. That said, the pandemic driven e-commerce shift and related surge in residential package delivery demand, coupled with a massive uptick in parcel carriers’ pricing power drove a resurgence in FedEx’ profitability. Recovering B2B activity has also played a material role. Material labor constraints emerged in recent quarters, setting margins back . Therefore, Morningstar analysts assuming management will be able to mitigate some of these headwinds with increased productivity, and ground margins should see some recovery in the quarters ahead.

In general, FedEx’ extensive international shipping network is extraordinarily difficult to duplicate and domestic/international e-commerce tailwinds should remain favorable for years to come (outside a major recession). Despite Amazon insourcing more of its own U.S. last-mile package deliveries, FedEx continues to bolster its ground and express capabilities and is well positioned to serve the myriad other retail shippers pursuing e-commerce, not to mention its entrenched relationships in B2B delivery. The TNT integration has made headway, and expects efforts to bear more fruit in Europe as FedEx finalizes the integration by May 2022.

Financial Strength

Total debt approached $21 billion as of fiscal year-end 2021 (ended May), down slightly from $22 billion in fiscal 2020. Since May 2017, FedEx has borrowed around $7 billion (net) to finance aircraft purchases, sorting facility expansion and automation, pension funding, dividends, and periodic share repurchases. This partly reflects $3 billion of unsecured debt issued in April 2020 to increase financial flexibility as the pandemic hit, and to pay off part of its commercial paper program. FedEx ended fiscal 2021 with $7 billion in cash and equivalents, up from $5 billion. Total debt/adjusted EBITDA came in near 2 times in fiscal 2021, which represents improvement from 3.3 times in fiscal 2020, as the operating backdrop improved significantly. We expect that metric to hold relatively steady in fiscal 2022. Adjusted EBITDA excludes mark-to-market pension charges and nonrecurring costs.

Bull Says

  • Outside a prolonged recession, FedEx’s U.S. ground package delivery operations should continue to enjoy robust growth tailwinds rooted in favorable ecommerce trends.
  • FedEx’s massive package sortation footprint, immense air and delivery fleet, and global operations knit together a presence that’s extraordinarily difficult to replicate.
  • During its nearly five-decade history, FedEx has weathered multiple economic cycles. While short term results may suffer, the firm’s powerful parcel delivery network is firmly established.

Company Profile

FedEx pioneered overnight delivery in 1973 and remains the world’s largest express package provider. In its fiscal 2020 (ended May 2020), FedEx derived 51% of revenue from its express division, 33% from ground, and 10% from freight, its asset-based less-than-truckload shipping segment. The remainder comes from other services, including FedEx Office, which provides document production/shipping, and FedEx Logistics, which provides global forwarding. FedEx acquired Dutch parcel delivery firm TNT Express in 2016. TNT was previously the fourth-largest global parcel delivery provider.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

We Expect Avery Dennison Will Enjoy Another Year of Strong Growth in 2022

Business Strategy and Outlook

 Avery Dennison is the largest supplier of pressure-sensitive adhesive materials and passive radio frequency identifiers in the world. Rising consumer packaged goods penetration in emerging markets should add to label growth, while growth in omnichannel retailing will aid RFID sales at Avery Dennison.

Avery sells pressure-sensitive materials to a highly fragmented customer base that converts specialty film rolls into labels for companies such as Kraft Heinz or Amazon. The concentrated market positions of Avery and competitor UPM Reflactac give each bargaining power over their customers. The labels and graphics materials, or LGM, and industrial and healthcare materials, or IHM, segments account for roughly 74% of company revenue. They convert paper, vinyl, and adhesives into composite films that become shipping labels, automotive graphics, and special-use tapes and films. While demand for these products is stagnant in developed markets, and expect Avery’s large emerging market footprint (around 40% of revenue for these segments) to drive mid-single-digit revenue growth.

 Avery’s Retail Branding and Information Systems segment, or RBIS, makes up 26% of sales and produces a mixture of apparel graphics, product tags, and passive radio frequency identifiers or RFID. While RFID accounts for around 25% of the segment’s revenue, it has grown rapidly in recent years and has increasingly become the focus of Avery’s RBIS segment. RFID products are typically integrated into product tags in industries which have both a diverse inventory and where UPC scanning is cumbersome or labour-intensive, such as apparel. Avery’s recent strategy shift to focus on reducing both costs and prices of the technology in order to gain share demonstrates the commoditized nature of these products. Even so, and think Avery will at least be able to grow with the market, or between 15% and 20% per year. The remainder of segment revenue comes from the application and production of apparel graphics and tags. It is expected expect revenue growth of these end uses to remain mixed, dependent largely on shifting fashion preferences.

Financial Strength

Avery Dennison is in very good financial health. The company ended 2021 with net debt/EBITDA of roughly 2.2, which gives the firm room to manoeuvre with regard to additional acquisitions, opportunistic share buybacks, or to boost its dividend. This remains just below management’s target range of 2.3-2.6, aimed at preserving its BBB credit rating. Avery’s target range of debt remains manageable, and shouldn’t become a material burden even if economic conditions worsen. Thanks to the amount of business Avery derives from consumer staples, cash flows usually remain relatively stable throughout the economic cycle.

Bulls Say’s

  • Emerging-market adoption of consumer-packaged goods will provide a long runway for sales growth. 
  • As RFID technology becomes widely adopted, Avery’s growth should receive a hefty tailwind. 
  • Avery’s dominance in retail branding information systems should lead to widening segment margins

Company Profile 

Avery Dennison manufactures pressure-sensitive materials, merchandise tags, and labels. The company also runs a specialty converting business that produces radio-frequency identification inlays and labels. Avery Dennison draws a significant amount of revenue from outside the United States, with international operations accounting for the majority of total sales.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Mondelez’s management refraining from quantifying its cost-saving aims

Stock exchange market concept, stock broker looking at graph working and analyzing with display screen, pointing on the data presented and deal on a exchange, Businessman trading stocks online.

Business Strategy and Outlook

Since taking the helm at Mondelez four years ago, CEO Dirk Van de Put has orchestrated a plan to drive balanced sales and profit growth by empowering local leaders, extending the distribution of its fare, and facilitating more agility as it relates to product innovation (aims that are hitting the mark). It wasn’t surprising reigniting the top line was at the forefront of its strategic direction. More specifically, Mondelez targets 3%-plus sales growth long term as it works to sell its wares in more channels and reinvests in new products aligned with consumer trends at home and abroad. Further, it has looked to acquire niche brands to build out its category and geographic exposure, which is seen to be prudent. 

But despite opportunities to bolster sales, it weren’t anticipated the pendulum to shift entirely to top-line gains under Van de Put’s watch; rather, based on his tenure at privately held McCain Foods and past rhetoric, it is alleged driving consistently profitable growth would be the priority. As such, the suggestion showcase that Mondelez is poised to realize additional efficiency gains through fiscal 2022 favorably. While management has refrained from quantifying its cost-saving aims, it is seen an additional $750 million in costs (a low- to mid-single-digit percentage of cost of goods sold and operating expenses, excluding depreciation and amortization) it could remove (on top of the $1.5 billion realized before the pandemic). It is foreseen this can be achieved by extracting further complexity from its operations, including rationalizing its supplier base, parting ways with unprofitable brands, and continuing to upgrade its manufacturing facilities. 

It isn’t likely that, these savings to merely boost profits, though. In this vein, management has stressed a portion of any savings realized would fuel added spending behind its brands in the form of research, development, and marketing, supporting the brand intangible asset underpinning Mondelez’s wide moat. This aligns with analysts forecast for research, development, and marketing to edge up to nearly 7% of sales on average over the next 10 years (or about $2.4 billion annually), above historical levels of 6% ($1.7 billion).

Financial Strength

In assessing Mondelez’s balance sheet strength, it isn’t foreseen any material impediments to its financial flexibility. In this vein, Mondelez maintained $3.5 billion of cash on its balance sheet against $19.5 billion of total debt as of the end of fiscal 2021. Experts forecast free cash flow will average around 15% of sales annually over Experts 10-year explicit forecast (about $5.2 billion on average each year). And it is in view that returning excess cash to shareholders will remain a priority. Analysts forecast Mondelez will increase its shareholder dividend (which currently yields around 2%) in the high-single-digit range on average annually through fiscal 2031 (implying a payout ratio between just north of 40%), while also repurchasing around 2%-3% of shares outstanding annually. It is held Mondelez has proven itself a prudent capital allocator and could also opt to add on brands and businesses that extend its reach in untapped categories and/or geographies from time to time–although it is unlikely believe it has much of an appetite for a transformational deal. It is alleged the opportunity to expand its footprint into untapped markets–such as Indonesia and Germany–or into other adjacent snacking categories (like health and wellness) could be in the cards. Recent deals have included adding Tate’s Bake Shop for $500 million in 2018, Perfect Snacks (in 2019, refrigerated snack bars), Give & Go (2020, an in-store bakery operator),and Chipita (2021, Central and Eastern European croissants and baked goods) to its fold. But at just a low-single-digit percentage of sales, none of these deals are material enough to move the needle on its overall results.

Bulls Say’s

  • Mondelez’s decision to empower in-market leaders and fuel investments behind its local jewels (which historically had been starved in favor of its global brands) stands to incite growth in emerging markets for some time. 
  • Experts suggest the firm is committed to maintaining a stringent focus on extracting inefficiencies from its business, including the target to shed more than 25% of its noncore stock-keeping units to reduce complexity. 
  • Management has suggested it won’t sacrifice profit improvement merely to inflate its near-term sales profile, which is foreseen as a plus.

Company Profile 

Mondelez has operated as an independent organization since its split from the former Kraft Foods North American grocery business in October 2012. The firm is a leading player in the global snack arena with a presence in the biscuit (47% of sales), chocolate (32%), gum/candy (10%), beverage (4%), and cheese and grocery (7%) aisles. Mondelez’s portfolio includes well-known brands like Oreo, Chips Ahoy, Halls, Trident, and Cadbury, among others. The firm derives around one third of revenue from developing markets, nearly 40% from Europe, and the remainder from North America. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Shares Small Cap

COE’s results with production of 1.57 MMboe, up +31%; sales volumes of 2.02 MMboe, up +67%, and sales revenue of $95.4m, up +96%.

Shot of elegant smart businesswoman explaining a project to his colleagues with statistics on the computer on coworking place.

Investment Thesis:

  • Strong FY22 guidance provided by management. 
  • Sole will provide significant uplift in production and free cash flow. 
  • Sole’s volumes are mostly contracted out, which provides greater certainty at reduced exposure to price movements. 61% of COE’s 2P reserves (Proved and probable reserves) are under take-or-pay contracts, with uncontracted gas predominantly from 2024 onwards. 
  • Upside from COE’s exploration activity around Gippsland and Otway Basin. 
  • Strong management team led by CEO/MD David Maxwell, who has over 25 years industry / developing LNG projects with companies such as BG Group, Woodside Petroleum and Santos Ltd. 
  • Favorable industry conditions on the east coast gas market – with tight supply could lead to higher gas prices. 
  • Potential M&A activity – especially considering recent de-rating.

Key Risks:

  • Execution risk – Drilling and exploration risk.
  • Commodity price risk – movement in oil & gas price will impact uncontracted volumes. 
  • Regulatory risk – such as changes in tax regimes which adversely impact profitability. 
  • M&A risk – value destructive acquisition in order to add growth assets.
  • Financial risk – potentially deeply discounted equity raising to fund operating & exploration activities should debt markets tighten up due external macro factors.

Key Highlights:

  • COE’s management announced strong guidance relative to FY21: FY22 production guidance 3.0 – 3.4 MMboe (FY21: 2.63 MMboe); sales volume 3.7 – 4.0 MMboe (FY21: 3.01 MMboe); underlying EBITDAX $53 – $63m (FY21: $30m); capex of $24 – 28m (FY21: $32.3m).
  • COE achieved record results with production of 1.57 MMboe, up +31%; sales volumes of 2.02 MMboe, up +67%, and sales revenue of $95.4m, up +96%.
  • The +31% increase in total production to 1.57 MMboe, was driven by higher production from the Sole field and higher sales volumes contributed to a +163% increase in underlying EBITDAX to $25.5m.
  • COE was able to improve performance at Orbost Gas Processing Plant to drive earnings: Underlying EBITDAX up +163% to $25.5m; underlying net loss after tax of $6.0m (H1 FY21: $17.4m loss).
  • Step-change in total company gas production: H1 FY22 average daily rate of 50TJ/day, up +39% relative to 1H21 average daily rate of 36 TJ/day.
  • Athena Gas Plant sales began after successful commissioning.
  • COE retained a solid balance sheet with $92.2m in cash reserves at 31 December 2021.

Company Description:

Cooper Energy Ltd (COE) is an oil & gas exploration company focusing on its activities in the Cooper Basin of South Australia. The Company’s exploration portfolio includes six tenements located throughout the Basin. Gas accounts for the major share of the Company’s sales revenue, production and reserves. COE’s portfolio includes: (1) gas production of approximately 7PJ p.a. from the Otway Basin, most of which comes from the Casino Henry gas project which it operates. (2) COE is developing the Sole gas field to supply 24 PJ of gas p.a. from 2019. (3) Oil production of approximately 0.3 million barrels p.a. from low-cost operations in the Cooper Basin.   

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

AIG Targeting for an underlying combined ratio below 90% by the end of 2022

Business Strategy and Outlook

The years since the financial crisis have shown that American International Group would have destroyed substantial value even if it had never written a single credit default swap, had noncore businesses it needed to shed, and had material issues in its core operations that it needed to fix. It is encouraging, however, by the recent progress in terms of improving underwriting margins, and the plan to take out $1 billion in costs by 2022 would be another material step. In 2020, the impact of the coronavirus has obscured the company’s progress, but it is held results over the past year have been encouraging. COVID-19 losses to date have been very manageable. As a percentage of capital, losses have stayed well within the range of historical events that the industry has successfully absorbed in the past. 

The longer-term picture looks relatively bright. The pricing environment has not been particularly favorable in recent years. However, in 2019, pricing momentum picked up in primary lines, and this positive trend only accelerated in 2020. More recently, pricing has started to plateau, but the industry has enjoyed the highest pricing increases it has seen since 2003. While higher pricing is necessary to some extent to offset lower interest rates and a rise in social inflation, pricing increases appear to be more than offsetting these factors. As a result, commercial P&C insurers are experiencing a positive trend in underlying underwriting profitability, and potential for a truly hard pricing market can be seen, similar to the period that followed 9/11. 

It is seen AIG has made material progress in improving its under/over the past couple of years, and has set a target for an underlying combined ratio below 90% by the end of 2022. Assuming an average level of catastrophe losses, it is likely this is a level that would allow P&C operations to achieve an acceptable level of return, and a harder pricing market may make hitting this target easier.

Financial Strength

It is alleged AIG’s balance sheet is sound, although the company is arguably in a somewhat weaker position than peers until it can improve profitability. Equity/assets was 13% at the end of 2021. This level is lower than P&C peers but reasonable if AIG’s life insurance operations, which operate with higher balance sheet leverage, are considered. During 2014, the company reduced its debt load by about $10 billion and eliminated much of its high-coupon debt, which improved its financial flexibility. Barring any unforeseen events, it is anticipated the company has room to continue to return capital to shareholders, and management had been returning a lot of capital to shareholders, in part through divestitures and some restructuring, although in recent years management has curtailed buybacks as AIG pivoted toward growth and acquisitions have become part of the strategic plan

Bulls Say’s

  • The aftermath of AIG’s issues during the financial crisis occupied much of management’s attention for quite some time. With these issues resolved, management can focus on the company’s operations, and there could be ample scope for improvement. 
  • AIG has demonstrated progress in improving underwriting margins in its P&C business. 
  • The current focus on risk-adjusted returns sets a proper course for the company, and just increasing profitability to the level of its peers would represent a material improvement.

Company Profile 

American International Group is one of the largest insurance and financial services firms in the world and has a global footprint. It operates through a wide range of subsidiaries that provide property, casualty, and life insurance. Its revenue is split roughly evenly between commercial and consumer lines. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Airbnb Limiting Pebblebrook To Push Its Rates

Business Strategy and Outlook

Pebblebrook Hotel Trust is the largest U.S. lodging REIT focused on owning independent and boutique hotels. After Pebblebrook merged with LaSalle Hotel Properties in December 2018, the company owns 53 upper-upscale hotels, with more than 13,000 rooms located in urban, gateway markets. Pebblebrook’s combined portfolio has a higher revenue per available room price point and EBITDA margin than its hotel REIT peers. 

The recent merger with LaSalle provides Pebblebrook some new avenues to create value for shareholders. The company doubled in size while taking on only a portion of the general and administrative costs, making the combined company more efficient. Pebblebrook’s CEO, Jon Bortz, previously ran LaSalle and acquired many of the hotels in that portfolio. His knowledge of those hotels combined with management’s demonstrated ability to maximize margins should allow him to implement cost-saving initiatives that drive up margins. Additionally, management has begun an extensive renovation program across both the LaSalle portfolio and the legacy portfolio that will drive EBITDA gains over time. 

In the short term, the coronavirus outbreak significantly affected the operating results for Pebblebrook’s hotels, with high-double-digit revPAR declines and negative hotel EBITDA in 2020. However, the rapid rollout of vaccinations allowed leisure travel to quickly return, driving high growth in 2021. It is held the company should continue to see strong growth in 2022 and beyond as business and group travel eventually returns to 2019 levels by 2024 in analysts base-case scenario. However, there are several factors that will remain headwinds for hotels over the long term. Supply has been elevated in many of the biggest markets, and that is likely to continue for a few more years. Online travel agencies and online hotel reviews create immediate price discovery for consumers, preventing hotels from pushing rate increases even though it is nearing full occupancy on many nights. Finally, while the shadow supply created by Airbnb doesn’t directly compete most nights, it does limit Pebblebrook’s ability to push rates on nights when it would have typically generated its highest profits.

Financial Strength

Pebblebrook is in solid financial shape from a liquidity and a solvency perspective after the merger with LaSalle, but it is alleged that additional assets sales will put the company in great financial shape. The company seeks to maintain a solid but flexible balance sheet, which is anticipated will serve stakeholders well. Pebblebrook does not currently have an unsecured debt rating. Instead, it uses secured debt on its high-quality portfolio and takes out unsecured term loans. Debt maturities in the near term should be manageable through a combination of refinancing and the company’s free cash flow. Additionally, the company should be able to access the capital markets when acquisition opportunities arise. It is projected 2024, the year it is likely operations will fully return to normal, net debt/EBITDA and EBITDA/interest will be roughly 7.4 and 4.2 times, respectively, both of which are slightly outside of the long-term range for the company but should continue to improve over time.As a REIT, Pebblebrook is required to pay out 90% of its income as dividends to shareholders, which limits its ability to retain its cash flow. However, the company’s current run-rate dividend is easily covered by the company’s cash flow from operating activities, providing plenty of flexibility for capital allocation and investment decisions. It is held Pebblebrook will continue to be able to access the capital markets given its current solid balance sheet and its large, higher-quality, unencumbered asset base.

Bulls Say’s

  • Potentially accelerating economic growth may prolong a robust hotel cycle and benefit Pebblebrook’s portfolio and performance. 
  • The acquisition of the LaSalle Hotel Trust portfolio provides management many renovation opportunities to drive revenue and margin growth. 
  • After the merger, Pebblebrook’s larger size could increase the company’s negotiating power with online travel agencies.

Company Profile 

Pebblebrook Hotel Trust currently owns upper-upscale and luxury hotels with 13,247 rooms across 53 hotels in the United States. Pebblebrook acquired LaSalle Hotel Properties, which owned 10,451 rooms across 41 U.S. hotels, in December 2018, the company current Pebblebrook CEO founded in 1998, though management has sold many of those hotels over the past few years. Pebblebrook’s portfolio consists mostly of independent hotels with no brand affiliations, though the combined company does own and operate some hotels under Marriott, Starwood, InterContinental, Hilton, and Hyatt brands. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Qantas Airways – Omicron impact on 2H22 underlying EBITDA of ~$650m

Investment Thesis:

  • Attractive way to play the Covid reopen trade for investors.  
  • Aiming for all segments to deliver return on invested capital > weighted average cost of capital.
  • Strong position in the domestic market (Qantas Domestic and Jetstar continue to remain the two highest margin earning airlines in the domestic market).
  • Jetstar is well positioned for growth and rising demand in Asia. 
  • Partnership with Woolworths for Loyalty bodes well for membership and earnings.
  • Oil price hedging in FY22 could contribute to performance.
  • Increased competition in the international segment.
  • Relative to peers, strong balance sheet strength; investment grade credit rating.

Key Risks:

  • Disasters that could hurt the QAN brand.
  • Earnings recovery gets pushed out again due to travel restrictions or return of another Covid-19 variant. 
  • Ongoing price led competition forcing QAN to cut prices affecting margins.
  • Leveraged to the price of oil. 
  • Adverse currency movements result in less travel.
  • Labor strikes. 
  • Depressed economic conditions leading to less discretionary income to spend on travel. 

Key Highlights:

  • Omicron impact on 2H22 underlying EBITDA of ~$650m (after mitigations) with operating expenses for 2H22 to include ~$180m of inefficiencies and ramp up costs.
  • Domestic capacity to be 68% of pre-Covid levels in 3Q22, increasing to 90-100% in 4Q22, equating to total FY22 capacity of ~60%.
  • International capacity to be 22% of pre-Covid levels in 3Q22, increasing to 44% in 4Q22, equating to FY22 capacity of 18%.
  • Loyalty on track to deliver more than $1bn gross cash receipts in FY22 and remains committed to its target of $500-600m underlying EBIT by FY24 after returning to double-digit growth by end of CY22.
  • Net capex (excluding land proceeds) in FY22 of $850m and in FY23 of $2.3-2.4bn.
  • Underlying D&A in FY22 of $1.8bn.
  • Net debt within the $4.4-5.5bn target range by end of FY22 and at the bottom half of range from FY23 onwards.
  • The Recovery Plan delivered $840m in savings since the start of the program and remains on track to deliver greater than $900m by the end of FY22.
  • Balance Sheet repair continued with net debt reduction of -9.8% over pcp to $5.5bn (now within target range), refinancing A$300m bond maturing in May 2022.
  • Total liquidity of $4.3bn including $2.7bn cash and committed undrawn facilities of $1.6bn maturing in FY23 and FY24.
  • Investment grade credit rating of Baa2 from Moody’s maintained. 
  • Shareholder distributions remain on hold. 
  • 1H22 fuel cost declined -75% compared to pre-Covid-19 to $0.5bn, primarily due to a -74% reduction in fuel consumption. 

Company Description:

Qantas Airways Ltd (QAN) provides passenger and freight air transportation services in Australia and internationally. QAN also operates a frequent flyer loyalty program. QAN was founded in 1920 and is headquartered in Mascot, Australia.

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Norwegian liberally accessing the debt and equity markets since the start of the pandemic

Business Strategy and Outlook

Changes to consumer behavior surrounding travel–cruising in particular–as a result of the coronavirus could alter the economic performance of Norwegian Cruise Line Holdings over an extended horizon. As consumers resume cruising after the 15-month sailing halt that began in March 2020, cruise operators have had to add COVID-19-related protocols to reassure passengers of the safety of cruising in addition to the value proposition the holiday provides. On the yield side, it is anticipated Norwegian could intermittently see pricing competition to entice cruisers back onto the product once operators are back at full deployment. Further, there could be some pressure from the redemption of future cruise credits through 2022. On the cost side, higher spending to implement cleanliness and health protocols and oil prices could keep spending inflated. And the entire fleet will not be deployed until the second quarter of 2022, crimping near-term profits and ceding some scale benefits.

These concerns lead to average returns on invested capital, including goodwill, that is viewed, are set to fall below analysts’ 10.4% weighted average cost of capital estimate over a multiyear period, supporting analysts no-moat rating. While it is alleged Norwegian has carved out a compelling position in cruising thanks to its freestyle offering, the product still has to compete with other land-based vacations and discretionary spending for wallet share. It is resisted that it could be harder to capture the same percentage of spending over the near term, given the perceived risk of cruising, heightened by previous media attention. 

While liquidity issues remain concerning for cruise operators, Norwegian has liberally accessed the debt and equity markets since the beginning of the pandemic. Such capital market efforts signal Norwegian’s dedication to weathering a return to normalcy for demand. Given that the firm indicated cash burn is set to escalate to $390 million per month as it restarts the fleet, the $1.5 billion in cash of Norwegian’s balance sheet at year-end buys it sometime (even if there is no associated revenue) to facilitate a tactical full deployment strategy.

Financial Strength

Norwegian has accessed significant liquidity since the beginning of the pandemic, raising around $8 billion in debt and equity. In analysts’ opinion, these efforts signal Norwegian’s dedication to attempt to weather the duration of COVID-19. Given that the firm indicated cash burn should rise to around $390 million per month as it digests higher costs to restart the fleet, cash available to the firm should allow Norwegian time to successfully execute a tactical re-entry to sailing the seas, offering liquidity even in a tempered revenue scenario in 2022.With Norwegian’s 28 ships at the end of 2021, it is likely solid capacity expansion once cruising resumes, although it is likely some growth could be reconfigured, given shipyard closures. However, including recent debt and equity raises, Norwegian is likely to remain above its 2.5-2.75 times net debt/adjusted EBITDA target it had previously sought to achieve.  It is not seen Norwegian reaching around this range until 2028. The firm surpassed its debt/capital covenant of less than 70%, ending 2021 at around 84% (with restrictive covenants waived into 2022). The company is set to remain cash flow negative in 2022, but it is alleged could achieve positive EBITDA performance in the second half of 2022 (delayed a bit by omicron’s impact).Longer term, it is still held  that management will continue to order ships for delivery approximately every 18 months (and at least one per year in 2022-27) at its namesake brand and will opportunistically finance new ships through either compelling pricing in the debt markets or low-cost export credit agency guaranteed loans.

Bulls Say’s

  • As Norwegian is smaller than its North American cruise peers, it has the ability to deploy its assets nimbly as cruising demand rises, allowing for strategic pricing tactics. 
  • The rescission of restrictive COVID-related policies could allow cruises to appeal to a wider cohort of consumers, leading to near-term demand growth faster than is currently anticipated. 
  • Norwegian has capitalized on leisure industry knowledge from its prior sponsors as well as the addition of high-end Regent Seven Seas and Oceania brands, gathering best practices and leverage with vendors.

Company Profile 

Norwegian Cruise Line is the world’s third-largest cruise company by berths (at nearly 60,000), operating 28 ships across three brands (Norwegian, Oceania, and Regent Seven Seas), offering both freestyle and luxury cruising. The company is set to have its entire fleet back in the water in the second quarter of 2022. With nine passenger vessels on order among its brands through 2027 (representing 24,000 incremental berths), Norwegian is increasing capacity faster than its peers, expanding its brand globally. Norwegian sailed to around 500 global destinations before the pandemic. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

InterContinental Hotels Group PLC with over 100 million loyalty members

Business Strategy and Outlook

It is alleged InterContinental to retain its brand intangible asset (a source of its narrow moat rating) and expand room share in the hotel industry in the next decade. Renovated and newer brands supporting a favorable next-generation traveler position as well as its industry-leading loyalty program will drive this growth. The company currently has a mid-single-digit percentage share of global hotel rooms and 11% share of all industry pipeline rooms. It is seen its total room growth averaging 3%-4% over the next decade, above the 1.8% supply increase is projected for the U.S. industry. 

With 99% of rooms managed or franchised, InterContinental has an attractive recurring-fee business model with high returns on invested capital and significant switching costs (a second moat source) for property owners, as managed and franchised hotels have low fixed costs and capital requirements, and contracts lasting 20-30 years have meaningful cancellation costs for owners. 

It is anticipated InterContinental’s brand and switching cost advantage to strengthen, driven by new hotel brands, renovation of existing properties, technology integration, and a leading loyalty program, which all drive developer and traveler demand for the company. InterContinental has added six brands since 2016; it now has 16 in total. InterContinental announced in August 2021 a new luxury brand, with details to be provided soon. Additionally, the company announced a midscale concept in June 2017, Avid, which the company sees as addressing an underserved $20 billion market with 14 million guests, under a normal demand environment. Also, InterContinental has recently renovated its Crowne Plaza (13% of total room base) and Holiday Inn/Holiday Inn Express (62%) properties, which will support its brand advantage. Beyond this, the firm has over 100 million loyalty members, providing an immediate demand channel for third-party hotel owners joining its brand.

Financial Strength

InterContinental’s financial health remains good, despite COVID-19 challenges. InterContinental entered 2020 with net debt/EBITDA of 2.5 times, and its asset-light business model allows the company to operate with low fixed costs and stable unit growth, which led to $584 million in cash flow generation in 2021. During 2020, InterContinental took action to increase its liquidity profile, including suspending dividends and deferring discretionary capital expenditures. Also, the company tapped $425 million of its $1.3 billion credit facility, which has since been repaid. As a result, InterContinental has enough liquidity to operate at near zero revenue into 2023. It is likely banking partners would work to provide InterContinental liquidity as needed, given that the company holds a brand advantage, which will drive healthy cash flow as travel demand returns. InterContinental’s EBIT/interest coverage ratio of 5.4 times for 2019 was healthy, and it is held for it to average 9.1 times over the next five years after temporarily dipping to 3.4 times in 2021. It is projected the company generates about $2.3 billion in free cash flow (operating cash flow minus capital expenditures) during 2022-26, which it uses to pay down debt, distribute dividends, and repurchase shares (with the last two starting in 2022).

Bulls Say’s

  • InterContinental’s current mid-single-digit percentage of hotel industry room share is set to increase as the company controls 11% of the rooms in the global hotel industry pipeline. 
  • InterContinental is well positioned to benefit from the increasing presence of the next-generation traveler though emerging lifestyle brands Kimpton, Avid, Even, Hotel Indigo, Hualuxe, and Voco. 
  • InterContinental has a high exposure to recurring managed and franchised fees (around 95% of total operating income), which have high switching costs and generate strong ROIC.

Company Profile 

InterContinental Hotels Group operates 880,000 rooms across 16 brands addressing the midscale through luxury segments. Holiday Inn and Holiday Inn Express constitute the largest brand, while Hotel Indigo, Even, Hualuxe, Kimpton, and Voco are newer lifestyle brands experiencing strong demand. The company launched a midscale brand, Avid, in summer 2017 and closed on a 51% stake in Regent Hotels in July 2018. It acquired Six Senses in February 2019. Managed and franchised represent 99% of total rooms. As of Dec. 31, 2021, the Americas represents 57% of total rooms, with Greater China accounting for 18%; Europe, Asia, the Middle East, and Africa make up 25%. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

ARB Corporation Ltd reported strong 1H22 results, reflecting strong sales and earnings growth

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Investment Thesis

  • Experienced management team and senior staff with a track record of delivering earnings growth.  
  • Strong balance sheet with little leverage.
  • Strong presence and brands in the Australian aftermarket segment.
  • Growing presence in Europe and Middle East and potential to grow Exports.
  • Growth via acquisitions
  • Current trading multiples adequately price in the near-term growth opportunities.

Key Risks

  • Higher than expected sales growth rates. 
  • Any delays or interruptions in production, especially in Thailand which happens on an annual basis.
  • Increased competition in the Australian Aftermarket especially with competitors’ tendency to replicate ARB products.
  • Slowing down of demand from OEMs. 
  • Poor execution of R&D.
  • Currency exposure

1H22 result highlights

Relative to the pcp: 

  • Sales of $359m, up +26.5%, underpinned by solid customer demand across all segments. Sales Margin was maintained. 
  •  Profit after tax of $68.9m, and NPAT of $92.0m, were both up +27.6% relative to the pcp. 
  • The Board declared an interim fully franked dividend of 39.0cps compared with 29.0cps fully franked last year. Dividend payout ratio of 46% was higher than the 43% ratio in the pcp. 
  • Net cash provided by operating activities of $28.6m in 1H22, was driven by the profit after tax of $68.9m, offset by higher inventory holdings of $40.5m, as ARB sought to increase inventories in a challenging supply chain environment to facilitate continued sales growth. 
  • ARB retained a cash balance of $58.3m, a decrease of $26.4m from the June 2021 financial year end mainly due to expansionary capital purchases of PP&E for $27.0m and dividends paid to shareholders in October 2021 of $25.4m.

Company Profile

ARB Corporation Ltd (ARB) designs, manufactures, distributes, and sells 4-wheel drive vehicle accessories and light metal engineering works. It is predominantly based in Australia but also has presence in the US, Thailand, Middle East, and Europe. There are currently 61 ARB stores across Australia for aftermarket sales.

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.