UK Mail has now released its final results for the year ending 2015.
When compared to last year, overall revenues increased as a growth in parcels and courier revenue was partially offset by a fall in mail revenue. Cost of sales increased considerably, however, to give a gross profit some £8.8M lower than in 2014. Underlying admin expenses fell by £8M but non-underlying costs increased slightly as the £400K cost of automation implementation and the £2.5M in national hub costs were not entirely offset by a £2M compensation relating to HS2. We then see £9M in impairment costs, £1.4M in pallet business closure costs and a loss from the pallet business to give a profit for the year of £5.1M, £12.4M lower than last year.
When compared to the end point of last year, total assets increased by £11.9M, driven by a £35.3M increase in property, plant and equipment, a £3.8M growth in receivables and a £3.6M increase in intangible assets, partially counteracted by a £7.9M fall in the value of goodwill. Liabilities also increased during the year as an £18.2M increase in payables, a £9.4M increase in borrowings, a £1.1M growth in deferred tax liabilities and a £1.1M increase in provisions was partially offset by the elimination of £8.9M worth of deferred compensation and a £2.5M fall in current tax liabilities. Overall, net tangible assets fell by £1.9M to £52.9M which is still a decent balance sheet, although that large increase in current payables is a bit concerning and is not covered by receivables and cash.
Before movements in working capital, cash profits fell by £1M to £29.8M but due to a large increase in receivables, the net cash from operations stood at £23.6M, a decline of £4.6M year on year. This cash was no-where near enough to pay for the huge £39.1M of expenditure on property plant and equipment and after a further £6.4M spent on intangible assets with £7.7M relating to IT and some £3.9M on the network with the rest relating to automation and the new hub investments), partially offset by a £2M receipt of deferred compensation, the cash outflow before financing stood at a hefty £20.3M. The group then drew down £10M from the credit facility to pay the dividends (why not bite the bullet and conserve cash by having a dividend hiatus?) to give a cash outflow of £22.8M for the year as a whole to leave a cash level of £4.6M at the year-end – this is looking rather precarious with some £15M currently undrawn on the revolving credit facility with Lloyds.
The operating profit at the mail business fell by £200K to £12.5M. Revenues also fell despite an increase in volumes due to a change in mix towards Customer Direct Access mail, which carries substantially lower revenue per item. This change in mix came about due to the win of a very significant public sector contract during the year. The 4.7% increase in average daily mail volumes comes at a time when the UK market as a whole contracted by 3% so the group is gaining market share, albeit very low margin market share. The operating margin remained at a rather thin 5.2% during the year.
The web-to-print postal service continued to show good revenue growth and the group successfully launched ‘imailprint’ during the year which provides a specialist printing service which can produce printed documents for general use as well as being mailed. In addition to these new products, a key growth element of the Access Mail market is the rising popularity of packets where the group has a rather low market share. This has led to management reinvigorating the business, investing in specialist automated packets sorting equipment and increasing the size of their sales team.
The operating profit at the parcels business fell by £1.9M to £20.5M. The group achieved volume growth in both the B2B and B2C markets with daily volumes up 7% when compared to last year and an ongoing volume mix change towards the lower margin B2C segment. Volume growth in the final quarter was particularly strong, mainly due to the collapse of City Link which caused some challenges at they digested the new client volumes. This took the parcel volumes temporarily above the current operating capacity which resulted in above normal operating costs being incurred. While this will be resolved when the new hub becomes fully operational, it did impact profitability and operating margins this year which fell from 10.2% to 9.4%.
The ipostparcels business performed well during the year, improving both revenues and profits, and the group are investing further in the product. The enhanced next day delivery service, which offers advance notice one hour delivery windows, is now fully operational and includes a new texting service and tracking facility. The immediate priority for the parcels business is to complete the transfer to the new hub and then roll out automation to the target levels which will increase capacity and reduce operating costs.
The operating profit at the courier business fell by £500K to £2.7M despite an increase in revenue as the operating margin fell from 17% to 13.4%. The business has been undergoing a transition away from the traditional same-day courier operation towards one that provides specialist service support to the parcels business (whatever that means…) which resulted in the loss of some business during the year. Going forward, this business will be integrated into the parcels business and will no longer report separately. The pallets business endured a challenging few years in an increasingly competitive market which led to the decision to close it.
During the year there were some considerable exceptional costs. The cost of automation implementation represents the costs incurred during the final weeks of the year, mostly relating to contract termination costs, as the group moved towards the roll-out of new automation equipment. Further amounts are expected to be incurred in the next financial year. National hub relocation costs represent disturbance costs associated with the relocation of the national hub and offices. They comprise £200K in property costs associated with running two sites for about two months, £1.1M of recruitment and redundancy costs and £1.2M of costs relating to short term site operating costs due to the delay in the expansion of the old national hub as a result of the compulsory purchase. Full reimbursement of these costs is being sought from the DfT and further compensation amounts are expected to be received during 2016.
The other set of exceptional costs relates to the closure of the pallets business. The goodwill associated with the purchase of this business in 2003 was fully impaired which gave rise to an impairment cost of £7.9M which rather shows the danger of relying on goodwill assets on a balance sheet. In addition, some £1.1M worth of capitalised software development costs were also impaired. As well as the non-cash impairment costs, the group also incurred closure costs which related to £700K in redundancy costs and £700K in contract termination and additional dilapidation expenses.
This year has been one of preparing for the physical transition of the national hub which is proceeding on time and on budget. A lot of work remains for H1 2016 in order to complete this process and in addition, the overcapacity issues at the parcels business will likely to continue until the automation roll-out is fully completed in September. Currently some 20% of parcel volumes go through automated facilities which will increase to about 80% after the automation is complete with large sized parcels not being compatible with the equipment. In total, some £35M is expected to be spent on land and buildings over the next year with the group’s net contribution to the new hub being about £15M. In addition there is some £20M being spent on automation in the first half of the year.
Some of these innovations are mentioned above, but the key areas of new products that are being targeted are ipostparcels, which is a parcels collection and delivery service targeting the internet end-customer and small businesses; retail logistics, a parcel delivery service targeting the needs of retail businesses; imail, a hybrid web-to-print postal service; imailprint, an internet based printing service; and packets, a collection and delivery service in conjunction with Royal Mail’s delivery service. The group are also looking at including deliveries throughout the evening, making best use of their delivery sites and vehicles as well as providing flexibility for customers and alternative delivery and collection options such as retail stores and locker boxes.
Going forward, the board expects the first half of the new year to be challenging as they reposition their parcels business and manage the full integration to the new hub. In addition, the group is also rolling out the new automation equipment which will mean that the performance for the year will be more weighted to the second half than usual – a difficult six months is expected then.
At the current share price, due to the considerable non-underlying costs, the shares trade on a P/E ratio of 55.8 which falls to 17.1 on next year’s consensus forecast which looks a little costly to me. The underlying P/E is apparently 15.9 which suggests that next year is going to be a struggle. At the end of the year, the group had a net debt of £5.2M compared to a net cash position of £27M at the end of last year. At the current share price, the shares enjoy a yield of 4.2% but as we have seen, the group does not have the cash to pay the dividends, instead needing to pay them out of draw-downs of its credit facility. Next year, the yield is predicted to increase to 4.4%.
Overall then this has been a difficult year for the group. Reported profits fell considerably due to numerous one-off charges but underlying profits also fell. Net assets were down slightly and I am a little concerned about the huge increase in payables – no detail is given for the increase so I guess I will have to wait for the annual report to see what they are. Also, operational cash flow fell year on year, although this was entirely due to adverse working capital movements. There was nowhere near enough cash to pay for the capital expenditure though, and the group needed to borrow to pay the dividend. Profits at both the letters and parcels business fell as the group had to take on lower quality work in the letters sector due to the structural decline in the market and profitability in parcels was hit due to overcapacity following City Link’s demise, which is expected to continue until September at least.
The reported profit this year was hit by a complete impairment of goodwill. This seems rather strange to me – did the company not test the pallets business on an annual basis? Did the pallets business suddenly become unprofitable in just one year? I inherently don’t like goodwill as an asset class – all it represents is the amount the company paid over the fair value of the acquired company’s assets. Perhaps it should be amortised as the acquired company becomes integrated into the parent company? In any case, I tend to ignore it to calculate net asset values but I do believe in this case, it should have been partially impaired in previous years. In conclusion then, it seems that H1 next year is going to be difficult with more costs associated with the automation in particular, and with a P/E ratio suggesting the company is not currently good value, the share price is probably being propped up by the hefty dividend, which UKM is borrowing to pay for. I think the sensible option will be to wait on the side lines until the half year stage at least.
UK Mail has now released its annual report which gives a bit more detail to a number of areas.
We can see a little more detail in the cost of sales with a fall in royal mail access costs and employee costs being offset by a £10.6M increase in subcontractor costs and other cost of sales. Likewise, there is more detail in admin expenses with increases seen in operating lease rentals, repairs and maintenance and R&D in particular when compared to last year. It is also a small point, but I think it is a bit cheeky to capitalise those finance costs to make it look as though they reduced (some £300K was capitalised during the year).
Likewise we see some more detail on the balance sheet with the increase in intangible assets due to a growth in internal software developments and tangible assets increasing considerably with both buildings and equipment increasing considerable. The increase in receivables is due to “other debtors” so not so much useful information there. Payables, though, makes interesting reading as the fall in accruals more than made up for by the increase in deferred compensation (actually just moving from non-current to current assets) and a spectacular £15.8M increase in trade payables which looks a little concerning to me. Also, we get some detail about the operating leases outstanding and these increased by £4.2M to £40.6M which is not great considering net assets fell during the year.
I am not sure if this was included with the preliminary results but I notice that in the Chairman’s statement he suggests that the investments made in the last few years are about to bear fruit – specifically in the second half of this year supposedly.
The group hasn’t done very well with its KPIs this year with all the financial measurements (revenue growth, operating margin, ROCE, and free cash flow and all deteriorating year on year. The group did manage to improve on debtor days and waste recycling slightly but CO2 emissions and health and safety compliance reduced during the year. There were no KPIs that attempted to monitor customer satisfaction. As far as risks are concerned, clearly the main one this year is the implementation of the new hub and automation equipment.
There was one change in the board during the year. Carl Moore was appointed as operations director having previously served as Network Director. One thing that I did notice is that due to LTIP awards, the three executive directors all earned substantially more than last year with the cEO earning a total of £913K. This seems rather excessive to me given the performance of the company during the year.
Overall then, there is nothing here which really changes my mind. I still feel it will be best to wait for the interim report to see how the various upgrades are progressing. If anything, the huge increase in payables and the operating lease growth makes me more nervous.
On the 7th August the group released a trading statement covering the first four months of the year (basically it is a profit warning). To management’s credit they launch straight into it. It is not clear that the near-term challenges and their impact on the current year’s performance are more significant than anticipated. They have now completed the move of the Birmingham hub and head office to a new fully automated facility in Coventry with the relocation contract with HS2 expected to complete on the 10th August.
While parcel volumes for the first four months of the year were 4% ahead of the same period last year, the move has caused a greater level of customer churn and loss of volume than anticipated, with an associated adverse impact on parcels revenue mix. In addition, a greater than expected proportion of current parcels volumes in incompatible with the new sortation equipment, resulting in additional operating costs and a delay to the full benefits expected from automation, which management think will be achieved in the medium term.
The mail business continued to perform well, with volumes up by 6% during the first four months of the year, representing a further increase in market share of the access mail market. The group has recently won a number of major contracts and has a good pipeline of opportunities as a significant number of competitor contracts are now coming out to tender. The packets initiative also continued to make good progress with a strong pipeline of opportunities.
Overall, it is expected that performance for the current year will be materially below market expectations with profit before tax now expected to be in the range of £10M to £12M with some further impact in the first half of 2016. This is clearly disappointing and while a degree of customer churn is probably to be expected, the fact that a lot of the parcels are not even compatible with the new equipment is less forgivable in my view. This company does not look like a good investment to me at the current time.
On the 6th October the group released a half year update. Overall group performance is in line with expectations. Reported revenues from continuing operations increased by 4% compared to the same period last year. In the parcels business, daily volumes increased by 8% and they are now achieving improved rates of parcels volumes growth. This increase continues to be weighted towards B2C customers due to the growth in online shopping. In the mail business, average daily volumes were some 8% ahead of the same period last year and the group have won a number of major contracts and has a good pipeline of new opportunities.
Progress in the plan put in place to address the recent challenges associated with the parcels business has apparently been encouraging and a number of significant new customers are keen to use their services following the investment in the new hub.
Overall then, this could be the point at which fortunes for UKM turn a corner. Although there are clear risks and performance is only “in-line” this share has just got a bit more interesting.
On the 8th October the group announced that Carl Moore, Operations Director, is stepping down with immediate effect in order to pursue other interests. Peter fuller will replace him and join the board in early 2016 as Operations Director. He has experience in parcels distribution, most recently in Parcel Force, where he has been Operations Director since the end of 2011 so this looks like a sensible appointment.