Murtaza Jafferjee says Expo exit offer is “extremely generous”

• Makes compelling case to minority shareholders to accept Rs. 63 b offer

JB Securities Managing Director Murtaza Jafferjee, CFA

JB Securities Managing Director Murtaza Jafferjee, CFA  declared that the exit price on Expolanka Holdings Plc is “extremely generous.”

His assessment is cited in the JB Securities research note on Expolanka Holdings›s de-listing offer to minority shareholders at Rs. 185 per share. 

As per JB Securities› prognosis, the loss-making Expolanka’s actual share value is between Rs. 44 and Rs. 66.

Among key pointers listed by JB Securities were Expo’s comparator set (normalized) – Operational Expense growth has been contained and its operational expenses have not scaled down with the downturn in business. Noting that as LKR continues to appreciate, a firm with offshore business such as Expo will be worth less in LKR. “Losses and LKR appreciation driving down NAV,” JB Securities said adding “the trend will continue downwards.”

As per JB’s research, during pre-COVID, Expo’s quarterly revenues ranged between USD 120-150 Mn. It was mainly driven by handling 40-50 Mn kg of air freight (AF) and 50,000 TEUs of Ocean Freight (OF). During the FY21/22 peak quarterly revenues peaked between USD 1- 1.15 bn when volumes expanded on AF to 60 Mn kg and OF to 70-80,000 TEUs. During the past four quarters revenues are down to USD150-200 Mn due to a contraction in volumes on both AF and OF to 17-25 Mn kg and 30-40,000 TEUs respectively.

 The current volumes are less than pre-COVID levels indicating a reduction in market share and demand contraction.

Noting that GP margins are driven by both yields and volumes, JB said on AF, that yields during pre-COVID were around USD 0.30/kg, during the FY 21/22 peak they recorded USD 2.00/kg, and they are now around USD 0.30-0.40/kg. On OF, yields during pre-COVID were around USD 120-150/TEU, during the FY 21/22 peak they were between USD 1,000-1,250, and they are now around USD 250-300/TEU.

GP margins during pre-COVID were around USD 25 Mn per quarter, during the FY21/22 peak they went up 8x to record a high USD 200 Mn. They are now at USD 35 Mn, higher than pre-COVID levels due to a higher contribution from the trucking and warehouses business that they recently acquired.

JB also noted Operational expenses (OEs) during pre-COVID were around USD 22 Mn, during the FY 21/22 peak they went up to USD 70 Mn a quarter. The average for the past four quarters is around USD 50 Mn. Approximately 75% of these expenses are payroll. The US accounts for 40% of operational expenses. OEs having a large fixed cost component have NOT scaled down with the fall in GP.

There remains a gap of around USD 15 Mn a quarter between the GP and OEs, this implies an operational loss of around LKR 4.5 bn a quarter.

“The outlook for Q4 FY 23/24 looks bleak with weak demand in apparel and rates remaining subdued due to a strong recovery in supply in both air freight (more belly capacity) and ocean freight (new ships coming on stream),” JB argued.

“Unless urgent steps are taken to reverse the current situation the company will continue to bleed large amounts of money in the near term. The focus will have to be on cutting operational expenses for the market situation is beyond the control of the company. This will require significant cuts to payroll since it accounts for 75% of OEs,” JB added.

It said retrenching people is extremely hard for there are many legal minefields to be traversed through. “Redundancies are costly. Further, the biggest impact will be on employee morale,” JB added. It said the top leadership team will be tested severely for they have to keep and claw back some of the customer accounts that they seem to have lost and at the same time go through an almost 30% reduction in OEs to breakeven.

“What will further compound decision making will be cultural differences between the owners who are Japanese and management teams of many nationalities including both Asians and Americans,” it added.

JB said to value a loss-making company, one needs to go to the back of the envelope methodology.

“The current losses that the company is making are due to a cyclical downturn in the industry after a once-in-a-hundred-year boom a couple of years ago and company-specific factors. It is not likely that the industry cycle is going to turn anytime soon,” JB said.

The US’s COVID-19 stimulus was more than 20% of GDP, policymakers have now pivoted towards both contractionary monetary and fiscal policy hence demand for goods will be muted. On the supply side, cashed-up shipping lines have gone on a CAPEX binge so the Ocean Freight market will remain well supplied and airline travel is rebounding strongly providing ample belly capacity.

“Expo has taken on high overheads, a minimum 30% cut is required to break even. It is tough to increase yields in an oversupplied market. Volumes will have to increase through market share gains to grow gross profits,” JB said.

“Current quarterly GPs are in the range of USD 35 Mn, assuming a 25% growth in volumes going forward resulting in a GP of USD 43.75. If OEs are cut from USD 50 Mn to USD 35, they will record a pretax profit of USD 8.75 Mn. Let›s assume all quarters have a similar performance (Q2 and Q3 are better due to the holiday season) the annual pretax profit will be USD 35 Mn. The tax rate is around 20% which will result in an after-tax profit of USD 28 Mn,” JB pointed out. At an earnings multiple of 10x, one will get an equity value of USD 280 Mn (LKR 85.4 bn), at 15x it will be USD 420 Mn (LKR 128.1 bn), JB added.