Investors are at times faced with the dilemma of whether to buy out-of-favour businesses, which they suspect will increase in price when the business fundamentals improve, or do they wait for the fundamentals to improve and then buy.
A case in point at present is the transport and logistics sector, which is struggling with lower volumes, as higher interest rates and inflation put a dampener on consumer spending, meaning less products are shifted around the world, which combined with higher input costs, are squeezing already thin margins.
ASX listed Silk Logistics Holdings Ltd (ASX: SLH) is my preferred small cap transport and logistics play on the ASX, but I am not buying yet. I think the next few years will still be challenging as the effects of the sharpest rise in interest rates since the late 1980’s are still flowing through the economy.
How does Silk Logistics Ltd (ASX: SLH) make money?
Silk operates in Australia, servicing ports in the major Australia cities. Silk Logistics has two primary operating divisions. The first is the port logistics division which provides wharf cartage and container services. This involves the transport of freight to and from ports. Freight includes bulk and containerised goods, transport of shipping containers between ports and inland locations where containers are packed/unpacked.
The second is the contract logistics division which offers warehousing, e-commerce fulfillment and distribution services. Warehousing involves the management of facilities where goods are temporarily stored, and services such as packing and unpacking occur. Distribution involves the final transportation of goods, mainly by road, from warehouses to delivery points such as retail outlets, factories and households.
Why Silk Logistics Ltd (ASX: SLH) is interesting
Silk Logistics appears to be an under the radar company with only two share brokers following the business, according to Silk’s website. Silk Logistics only listed in July 2021 and the share price has steadily declined since. The recent listing and declining share price, plus the current sluggish economy means few are taking notice of Silk Logistics. However, company directors, who know the company well have been taking advantage of the depressed share price with substantial shares purchases recently.
Silk has increased revenue and earnings steadily over the last few years, although I will be waiting for the financial year 2024 results, which should be due out late August, to see if this trend continues. Approximately 70% of warehousing revenue is from recurring contracts across a diverse range of industries, which should keep revenues steadier than in some other businesses.
While a small cap company, Silk Logistics has scale, being the third largest port-to-door operator in Australia’s major cities. This gives it a competitive advantage over smaller players, some of which may find the current environment too challenging, thus helping Silk Logistics over the longer term.
As a cyclical business, investors can push the share price further down if they view the challenging economic conditions persisting, but when Australia’s economy does improve, the expected increased earnings growth, should also be enhanced by Silk Logistics recent acquisitions, which could see a rapid rise in the share price. Another avenue of growth is cross selling which Silk have espoused they can exploit, as 77% of Silk’s clients only use one of their various services.
Over the longer term transport and logistics businesses are unlikely to be disrupted in any meaningful way and are likely to benefit from new technology. Goods will always need to be moved from one country to another, as no country can produce everything they need conveniently and cheaply. Ports will always be needed to control what comes into the country and companies are unlikely to want to navigate the port system themselves due to regulations and rules. Transport and logistics should benefit from technological advances in electric vehicles and self-driving technology, plus logistics software may improve with Artificial Intelligence (AI).
It remains to be seen who captures the value of these advances, as that will depend on emerging competitive dynamics. I believe Silk may be in a position to enhance efficiency with emerging technology over time, but it is possible any margin gains could be competed away.
Silk Logistics Ltd (ASX: SLH) half year results show revenue growth
In the half year to December 2023, Silk’s revenue increased 9% to $276.5 million on the prior corresponding period (pcp). The growth came from new business secured and an increase in customers to 594 (up from 569 at 30 June 2023), excluding recent acquisition Secon Freight Logistics.
Revenue is split fairly evenly between the port and contract divisions with port activities accounting for ~59%, and contract accounting for ~41% of revenue. Underlying Net Profit before Tax (NPAT), was down 22.4% to $7.6 million against the pcp, primarily driven by higher input, labour and finance costs, plus additional right-of-use (property lease) depreciation expenses.
Operating cashflow was $33m, and capital expenditure was $5.7 million, even ignoring the $29 million spent on acquisitions. Lease repayments for the half were $24m, leading to underlying free cash flow of just $3.3 million. Net debt was $34.5 million at 31 December 2024. EBITDA in FY 2023 was $86m, and was up 7% in the first half.
Management provided an outlook for the full year to June 2024 for revenue of between $540 and $560 million, which is up on financial year 2023 of $488.6 million and Underlying EBITDA of between $92 million and $98 million.
At a share price of around $1.45, Silk has market capitalisation of about $120m. So based on FY 2024 underlying EBITDA, it is trading at an EV / EBITDA ratio of considerably less than 2.
A look at Silk Logistics Management
Co-founder, Managing Director and Chief Executive Officer, Brendan Boyd, has retired from his current executive role for medical reasons, effective late May, but will continue as a Non-Executive Director. Co-Founder and current Executive Director and Chief Customer Officer, Mr John Sood, will be Boyd’s successor.
Over the last year there have been three director buys and no sells. Non-Executive director Cheryl Hayman bought $92,000 worth of shares on-market in August last year. In early March co-founder and Managing Director and Chief Executive Officer John Sood purchased $300,801 worth of shares on-market, bringing his total holdings to 11,001,794 shares, which gives him 13.49% of the company and co-founder and Executive Director Brendan Boyd bought $152,189 worth, bringing his total holdings to 10,853,294, giving him 13.30% of the business.
These two co-founders have been with Silk Logistics since forming it almost eleven years ago. They are both highly regarded within the industry and while Brendan is stepping back a bit, he is still with the company, and more importantly, still purchasing shares!
Silk Logistics acquisitions since listing
Silk has made three acquisitions since listing in 2021 and the company said they have no plans for any more in the near future, but longer-term appear to have a desire for acquisition growth.
The most recent was Victorian ports logistics business Secon, acquired for $35m in August 2023, improving port and bulk logistics capabilities.
In July 2022 Silk acquired Fremantle Freight & Storage, which operates across four sites in metropolitan Perth and provides wharf cartage, warehousing, quarantine, fumigation and other complementary port-related services.
In January 2022 Silk acquired 101Warehousing, a Victorian-based contract logistics service provider. 101Warehousing provides warehousing and distribution services to the fashion, homewares and toys sectors. Consumer discretionary spending is sluggish at present, but will recover at some point, and online shopping appears to show continued growth.
As you can see from the below chart Silk Logistics customer number growth has been reliant on acquisitions, and it does not seem to be winning new customers organically, even during the strong GDP Growth at the end of 2021.
Risks for Silk Logistics
Margins matter, and Silk is a low margin business. Transport and logistics businesses are highly cyclical, and the Australian economy had its lowest rate of growth in six quarters growing a paltry 0.1% in the March 2024 quarter. Savings rates are running down with household savings decreasing 0.9% over the period. At the other end, higher input cost are also squeezing margins.
While management are not planning any acquisitions in the current economic climate, in the long term there will likely be more acquisition activity which could present acquisition risk, meaning the target company does not integrate with Silk well. Although the acquirer can do plenty of due diligence, there can often be nasty surprises in target companies.
Is Silk Logistics a buy?
I think Silk is an investable company, but I am holding off on buying. While shares in a business should be purchased based on fundamentals, it often pays to consider share price momentum and the Silk share price is still trending steadily down, having declined 42% since a high of $2.55 in February last year and 26% since listing at $2 per share in July 2021.
When more stable economic conditions arrive, the recent acquisitions, plus an improving economy should see profits increase considerably, due to operating leverage. That makes it a worthy addition to the watchlist of ASX small cap investors.
Personally, I’m concerned that the effects of higher rates and inflation are still flowing through the Australian economy, meaning less volume of freight for the foreseeable future. Australia’s Reserve Bank was late in raising rates and inflation is still persistent.
Therefore, I personally will be waiting and watching for the right time to purchase Silk Logistics shares. The setup I am looking for is an improvement in trading conditions on a more stable economic outlook for Australia, that leads to organic customer and revenue growth.
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Disclosure: The author, Chris Coe, does not own shares in SLH and will not trade shares in SLH for at least 2 business days after the publication of this article. The editor of this article Claude Walker also does not own shares in SLH and also will not trade the stock for at least 2 business days after the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
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