Wincanton unduly cheap

Five years on, the call has been partly vindicated. Wincanton’s (WIN) profitability, free cash flow generation and book value have all gradually improved, although a highly commoditised core product – transport and storage services – leaves little room for error, particularly when the odd contract is lost. In the event, it was less momentum than the pandemic’s explosive impact that highlighted the group’s value, as online retail truly took hold and everyone gained a greater appreciation of the just-in-time delivery systems on which we have come to rely.

Two high-profile acquisitions in the past year have helped underline this shift in investor thinking. First was the tussle for WM Morrison, eventually won by private equity firm Clayton, Dubilier & Rice, which emphasised the attraction of the supermarket’s vertically integrated supply chain. Then came last month’s cash-and-shares bid for Wincanton rival Clipper Logistics (CLG). The offer, which would-be acquirer GXO Logistics (US:GXO) pitched at a 32 per cent premium to Clipper's three-month average share price, was struck at 30 times consensus forecast earnings for the next 12 months, according to FactSet.

Since their 2020 nadir, Clipper's shares have climbed fivefold. Wincanton, by contrast, is up a mere 90 per cent, barely ahead of its price immediately prior to the pandemic, and without attracting anything in the way of a market premium. On several classic valuation multiples – price-to-sales, enterprise value to cash profits, dividend yield and forward price-to-earnings – the group’s shares trade at or below their five-year average, despite several signs of an improving market backdrop.

Clipper, it should be noted, has been growing at a faster pace, thanks to its greater focus on the efulfilment and electronic product repair services. But we think the wide valuation gap between the two companies no longer makes sense. Neither do analysts at Peel Hunt, who described the GXO offer as having a “very positive read-across for Wincanton, where underlying growth rates are improving and the exposure to faster-growing parts of the logistics market, such as efulfilment, are rising”.

Momentum undimmed

Chippenham-headquartered Wincanton is a leading provider of supply chain solutions in the UK and Ireland. Though plenty of this work amounts to road haulage and warehouse management for private and public sector customers, Wincanton’s services are increasingly varied and specialised. They include last-mile delivery, labour resourcing, supply chain software, white-glove home delivery and even an online marketplace – oneVASTwarehouse.com – which links buyers and sellers of storage space. These are provided across four sectors: grocery and consumer, ecommerce, general merchandise, and public and industrial – the latter of which arguably gives the group greater customer diversification than Clipper.

In the six months to September 2021, group profits exceeded pre-pandemic levels, despite well-documented driver shortages and other supply chain issues. Sales rose 19 per cent to £690mn, a figureanalysts expect to be repeated in the second half of the current financial year. The interim dividend kicked up to 4p a share, while the group’s pension scheme – long a source of market angst – edged up to a £70.2mn net surplus, thereby pushing the balance sheet into the black.

Strong top-line growth has continued since then. Revenues jumped 15 per cent year-on-year in the three months to Christmas, thanks to strong showings within the grocery and digital arms. Investments in efulfilment and automation started to bear fruit, the first Christmas managing online orders for Waitrose was hailed as a success, and reassuring noises were made around cost pressure mitigation. As a result, management said full-year profits were likely to be ahead of consensus forecasts, prompting analysts to lift their earnings estimates to 37.4p a share for the year.

Despite this, Wincanton's shares have since dipped amid growing investor concern with inflation and the fallout from Russia’s invasion of Ukraine. Given the group’s exposure to consumer sentiment and economic activity, this shouldn’t come as a massive surprise. Looked at another way, the ongoing stress facing global supply chains serves as a further reminder to companies of the importance of quality logistics provision, and the need to pay up for that service.

The recent sell-off also suggests investors have underweighted Wincanton’s pricing power. Less than a fifth of the group’s revenue comes from closed-book transport contracts, 90 per cent of which saw price increases or exits in the period to September. Much of the remainder of the group’s contracts are structured as ‘open book’ or 'cost-plus', meaning customers pay for costs incurred plus an agreed margin. This doesn’t free Wincanton from inflationary pressures, but it certainly helps.

Supply chain reaction

So why would a buyer be attracted? Surely, one might assume, there are limits to the efficiencies a prospective acquirer can eke out from a company that specialises in efficiency. However, as GXO’s bid for Clipper shows, companies with innovative or profitable processes at a micro level are always valuable to firms who can scale those processes across geographies, sectors or new client bases.

This is particularly true of the somewhat fragmented world of logistics. In a 2016 report, consultants at PwC argued that the sector was ripe for consolidation, given that “network size and efficiency continue to be key sources of competitive advantage”. According to fellow accountancy group BDO, last year was a record for logistics acquisition activity in the UK – a trend reflected in global figures compiled by financial data provider Refinitiv.

Wincanton itself has been no stranger to M&A. In 2019, it tabled a bid to buy rival Eddie Stobart Logistics, whose haulage business was coveted by chief executive James Wroath. Interest was later withdrawn, over “financial performance and ongoing liquidity” concerns with Stobart. Wroath returned to the deal-making table last year with the £24mn purchase of Cygnia, a specialist multichannel retail fulfilment and contract packing business that works with consumer-facing brands including BrewDog and Moonpig.

Because logistics involves striking a fine balance between receivables and payables, companies in the sector rarely possess oodles of spare cash for deal-making. For several years, Wincanton’s current ratio – the proportion of current assets to current liabilities – has been stubbornly low at around 60 per cent, suggesting working capital management is very tight. In one sense, this might help explain Wincanton’s lower market rating: investors are aware of the need to sweat assets hard to juice returns, and so assume a higher cost of capital.

If this is the case, then there are a couple of reasons why it might be short-sighted. The first is that Wincanton has access to plenty of liquidity. At the end of September, the group’s committed facilities amounted to £141mn, following the expiry of an emergency £40mn revolving credit facility taken out as a pandemic backstop in May 2020. Day-to-day cash management is also supported by two credit lines with Santander that total £57.5mn.

Wincanton’s profitability is also stronger than it looks. In the year to September, its return on invested capital came to 23 per cent, and the return on cash has not been far behind. The company also scores particularly well on a test of quality favoured by US investor Joel Greenblatt – the ratio of operating profit generated relative to tangible assets. This measure, which defines tangible assets as net fixed assets plus working capital, arguably underplays investments in the ‘know-how’ crucial to efficiency gains, but is nonetheless a useful indicator of the efficiency with which hard assets are being used to make profits.

In the years we’ve been banging the drum for Wincanton shares, never have the company’s services been so highly valued. Admittedly, inflation has never been so large an issue either, which of course matters to any business with a single-digit operating profit margin. But contract terms, stronger pricing power, and business growth all offer reasons for investor optimism – regardless of whether Wincanton goes the way of Clipper and is snapped up by a better-capitalised rival.

Last IC View: Hold, 396p, 19 Nov 2021