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Turbulent times for John Menzies

The group’s shift to a pure play aviation services business has had a bumpy take-off
September 19, 2019

Selling its newspaper and magazine distribution arm to a private equity firm last September was meant to herald a new era for John Menzies (MNZS). But life as a pure-play aviation services business hasn’t exactly gone according to plan. With a profit warning in July sending the shares down to a new 52-week low, and we'd encourage shareholders to eject to avoid a potential downward spiral.

IC TIP: Sell at 394p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Fragmented market

Cost savings programme

Bear points

Aviation industry challenges

Profit warning

High net debt

Low margins 

The first half of 2019 saw underlying operating profit drop 14 per cent to £17.9m, reflecting a margin of just 2.8 per cent. Cargo handling services were hit by lower volumes amid a cooling global economy and intensifying US-China trade war. Also hindering fuelling and ground-handling activities, the grounding of Boeing’s 737 Max jet hit passenger demand.

Full-year earnings are expected to be flat, at best. Achieving this will require a big second half, even by the company's usual standards, which is to deliver about two-thirds of aviation profits in the final six months of the year due to the seasonality of the industry. Planned cost savings of £10m by 2020 and recent contract renewals on improved margins provide some encouragement. However, industry data doesn’t inspire confidence. The International Air Transport Association (IATA) reports that global air freight tonne kilometres – a measure of air cargo demand – contracted by 3.2 per cent year on year in July, the ninth consecutive month of decline. A soft start to the peak summer season for passenger demand compounds the tepid outlook.

The earnings decline is not solely down to external industry challenges. Menzies lost two exclusive licences in the Dominican Republic and Panama in the second half of 2018. Several unprofitable US operations have been closed while persistent staff turnover issues have meant Menzies has increased its prices. Similarly, tight labour markets in Europe have spurred increased recruitment, training and overtime costs.

Recent boardroom upheaval mirrors the turbulent backdrop. The departure of chairman Dermot Smurfit a week after July’s profit warning follows the departure of a chief executive, Forsyth Black, in March after just six months in the job. Having agitated for the separation of Menzies’ distribution and aviation services businesses since 2015, activist investor Lakestreet Capital (the fifth-largest shareholder) now wields greater influence – its chief executive sits on a new “strategic committee” overseeing key decisions, capital investment and acquisitions.

The big picture for Menzies sounds promising, in theory. The market for aviation services is highly fragmented and much work is yet to be outsourced. Menzies' market share of just 3 per cent makes it a leading player, and illustrates why management sees major scope for acquisitions. However, progress to date, and especially the rise in debt levels, leaves us underwhelmed. From the end of 2014 to the end of 2018, net debt rose by £89m. The picture is clouded by acquisitions, disposals and rights issues, but the net cash outflow associated with such items from the cash-flow statements over the period is less than the increase in debt at £74m (acquisitions-less-acquired-cash of £198m, disposal proceeds of £51m and rights issue proceeds of £73m). Meanwhile, at the end of June net debt represented 2.8 times cash profit (Ebitda), well above the target of 1.5 to 2 times. Adding in debt-like lease liabilities takes net debt from £215m to £422m.

Another side effect of the period of intense change at Menzies are the wide-ranging adjustments made to reported earnings, which make it hard to get a clear picture of profitability. The effect of adjustments on reported aviation profits over the last five years can be seen in the accompanying graph. At the group level, adjusted profit before tax of £44.1 last year compared with a statutory profit of £21.6m; the year before that £42.3m compared with £9.9m.

JOHN MENZIES (MNZS)   
ORD PRICE:394pMARKET VALUE:£328m 
TOUCH:394-395p12-MONTH HIGH:590pLOW:354p
FORWARD DIVIDEND YIELD:5.2%FORWARD PE RATIO:9 
NET ASSET VALUE:102p*NET DEBT:£215m 
Year to 31 DecTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20162.0749.747.818.5
20172.5267.157.220.5
20181.2944.137.620.5
2019**1.3941.935.020.5
2020**1.4752.443.820.6
% change+7+25+25-
Normal market size:1,000    
Beta:0.55    
*Includes intangibles of £175m, or 208p a share
**Berenberg forecasts, adjusted PTP and EPS figures