Company update: Wounded by tumbling freight rates
• IFF segment suffered from tumbling freight rates and weaker demand but the worst should be over
• Disposed some express service subsidiaries in Asia Pacific and Europe to parent SF Holdings
• Cut FY23-24F earnings by 62% and 43% to reflect weaker-than expected IFF business
• Negatives priced in; Maintain BUY despite lower TP of HK$10.50
Global freight rates have experienced unprecedented declines, resulting from subdued global demand and increased carrier capacity. This, coupled with lower business volume due to weaker trade flows amid the global economic slowdown and heightened geopolitical tension, has dealt a blow the performance of the International freight forwarding (IFF) segment, which used to be the growth engine for KLN. Margin, has thus, normalised to the pre-COVID level of 3-4%, vs a peak of c.7.4% in 1H22. Overall, we forecast IFF’s segment profit to post a sharp decline of 79% in FY23. Nevertheless, freight rates are seeing signs of bottoming out in 2Q23 as shipping companies have decided to pull out capacities. Shipment orders are also picking up with the destocking campaign by manufacturers coming to an end. As such, segment profit from IFF business should stage >25% growth q-o-q in 2Q23, with sequential improvement envisaged for the rest of the year.
Meanwhile, integrated logistics (IL) saw modest segmental profit growth in 1H23, primarily led by the business rebound in China which was battered by COVID outbreak and city lockdown in 1H22. Were it not for weaker earnings from Hong Kong IL operations, which benefitted from pandemic-related demand in 1H22, the growth would have been stronger. Overall, we expect the IL business to deliver modest earnings growth in FY23.
Kerry Express Thailand (KETH) continued to record profit loss amid tapered private consumption and lackluster economic outlook. It is expected to return to profitability by the end of 2024.
In Jul-23, KLN announced the disposal of its express business in Asia Pacific and Europe, excluding Hong Kong and Kerry Express Thailand (KETH), to its parent company, S.F. Holding, for a total consideration of no more than HK$250m. We believe this move aims to further streamline its operations and strengthen its focus on IL and IFF businesses. We do not rule out more business restructuring within the group. The proceeds will be used for debt repayment and working capital requirement.
Overall, we cut our core earnings forecast for FY23 and FY24 by 62% and 43% reflecting weaker profitability of IFF and continued losses from Kerry Express Thailand (KETH).
YTD, share price of KLN has fallen 36%, underperforming the broad market by 34ppts. Following the heavy sell off, the stock is now trading at a PE of 16.6x in FY23, which will improve to 9.4x in FY24, against its 5-year average of 13.3x. We believe that operating challenges should be largely factored in. The worst should be behind us with a gradual recovery expected from 2H23 onwards. Longer term, a higher stock valuation is warranted should the benefits from integration with SF Holdings come through. Maintain BUY despite a lower TP of HK$10.50. This is based on 11.0x FY24F PE, 0.5 SD below its 5-year average.