We recently researched Qube Holdings (ASX:QUB) after the share price had fallen from its recent peak. With the share price having edged higher these past couple of weeks, is the downside over? Or can investors purchase the shares at cheaper levels?

Overview Of Qube Holdings

QUB provides comprehensive logistics solutions across multiple aspects of the import-export supply chain. The Company’s Operating Division comprises two core business units: Logistics & Infrastructure and Ports & Bulk.

Logistics & Infrastructure provides a broad range of services relating to the import and export of mainly containerised cargo. It also includes outsourced industrial logistics services across heavy transport, mobile crane and renewable energy industries.

Ports & Bulk has two core activities comprising port logistics and bulk logistics. It provides a range of logistics services relating to the import and export of mainly non-containerised freight. It has a major focus on automotive, forestry, bulk and break bulk products. The Company’s port logistics activities are focused on the provision of an integrated logistics solution for the automotive industry. It covers a range of activities including stevedoring, processing, and delivery. QUB also provides stevedoring and related logistics services for the energy industry, forestry products and project and general cargo.

Bulk logistics activities are aimed at offering customers a comprehensive logistics solution from mine-to-ship. It covers activities including transport, stockpile management, storage facilities, and stevedoring. QUB handles a diverse range of commodities including iron ore, copper, nickel concentrate, and mineral sands.

QUB also owns a 50% interest in Patrick. This is an operator of container stevedoring services in Australia’s four largest container terminal ports.

Key Fundamental Drivers

Improving Earnings Outlook & Quality

Notwithstanding a mixed performance for the operating businesses for the six months to 31 December 2022 (1H23), QUB lifted its FY23 guidance for ‘strong growth’ in Group Net Profit After Tax & Amortisation (NPATA) and Earnings Per Share (on a pre-amortisation basis), from previous guidance of just ‘growth’, However, management expect EBITA for 2H23 to be lower than 1H23 on lower container volumes and impacts of severe weather.

In addition, the Company expect EBITA margin to improve in FY24 as a result of pricing escalation and resolution of labour constraints. In addition, there is spare capacity in many parts of the business. As such, QUB are well positioned to absorb incremental customer volumes at supportive margins.

In addition to an improved earnings outlook, earnings quality has also improved. QUB presents its underlying results on a pre-AASB16 basis but its statutory cashflow is on a AASB16 basis. As such, it is not easy to immediately confirm underlying EBITDA cashflow conversion and therefore the earnings quality. According to QUB’s disclosures, the cashflow conversion ratio improved to 83% in 1H23, from 71% in FY22. The Company also commented that this ratio has improved to ~92% in the 2H23 period to date and expects further improvement across the year.

Balance Sheet Capacity to Pursue Acquisitions

Gearing (on a Net Debt to (Net debt + Equity) basis) as at 31 December 2022 was 22.8%. This was broadly unchanged from 30 June 2022 and remains below the Company’s target gearing range of 30-40%. As such, this provides the Company with an opportunity to undertake incremental project capital expenditure (CAPEX) as well as pursue Merger & Acquisition (M&A) opportunities.

Acquisitions are important from the viewpoint that they can offer a defence against a slower macro environment and may alleviate pressure on free cashflow as a result of increasing CAPEX requirements. The majority of this is maintenance CAPEX, as opposed to growth CAPEX.

At the 1H23 results release, QUB commented that it is well progressed with a few bolt-on acquisitions that could complete in 2H23 or 1H24. This would supplement earnings growth.

Return Targets May be Achieved Earlier than Expected

The Company is targeting an improvement in Return on Average Capital Employed (ROACE) to 10% “in the medium term”. QUB made solid progress on this front during 1H23, with ROACE lifting from 8.0% in FY22 to 8.9% in 1H23. The Operating Division and Patrick both saw returns improve. ROACE for the Operating Division improved +0.6% to 10.2%, while Patrick’s ROACE improved +1.2%pts to 8.6%. The Company has a ROACE target of 10%, with the Company expect to reach this target “in the medium term”.

The better-than-expected jump in ROACE in 1H23 reflects better utilisation of QUB’s assets and also suggests upside risk to the 10% ROACE target, given that: a) Utilisation of the strong balance sheet position on new acquisitions/investments will also have a ROACE hurdle of >10% and b) The retention of full ownership of the intermodal terminals following the sale of MLP is likely to result in these assets generating a return above the WACC (~8.5-9.0% according to Company disclosures).

Fundamental View

Although the shares have moved higher in the past few weeks, the de-rating of the trading multiple over the last six months still sees the shares currently trading on a 1-year forward P/E multiple that remains low (~23x) compared to the multiple over the last two years. Further, the current multiple appears undemanding in the context of an EPS growth profile of 14% over FY22-25 on a CAGR basis. In context, while QUB has substantially de-rated, so have other global transport and logistics providers, such that QUB still carries a large premium to its global peers.

Further, we consider that there is upside risk to EPS growth estimates from a quicker improvement in group EBITA margin. In particular, from the Ports & Bulk segment and spare capacity in many parts of the business that allow QUB scope to absorb incremental customer volumes at supportive margins.

Charting View

QUB shares formed an “evening star” reversal in February (circled). The move down recently has been on higher volume and the recent rally has been on lower volume. This means that there is still a risk that we see cheaper levels in QUB. Therefore, for the short-term, risk is to the downside and investors can therefore be patient to get it cheaper. Nearby support is at $2.75.

 

Michael Gable is managing director of Fairmont Equities.

 

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