DX Group - Delivering on AIM


DX Group Logo

The main board of the London Stock Exchange has enjoyed a strong IPO pipeline, particularly over the past six months with heavyweights such as Royal Mail Group (LSE:RMG) listing and making substantial gains on their IPO price. Those positive sentiments have rubbed off on the latest listing, this time on AIM, and in the form of DX Group - a less well-known letters and parcels delivery company. The shares have enjoyed a strong start to trading with the shares marked up 30% upon the 100p IPO price to currently trade at 130p/share. With ~201m shares in issue, the company is valued at around £261m, making it one of the largest ever listings on AIM. In such a difficult industry, can DX generate sustainable shareholder returns for shareholders?

As is the case with newly listed companies, there are no past trading records thus technical analysis goes out of the window. The only chart that we can look at is for the couple days that DX has been listed for. The shares initially spiked up to 136p but quickly fell back to 128p. This almost certainly represents profit taking by investors who had bought into the IPO and 100p, whether that is private investors or institutions aiming to re-weight their portfolios. The shares quickly found support and a floor at 130p, where they now trade.

The lack of movement over the last day is interesting and it represents a short-term equilibrium between buyers and sellers, and that the equilibrium will give way in coming days which will determine the medium-term outlook for DX. The movement of the break is worth keeping an eye on for that reason, and it is important to recognise that many newly listed firms have volatile share prices in their first few weeks in trading. Private investors' knowledge about DX is likely to be low currently given the short trading period, and ultimately it will therefore lie within the fundamentals, as to whether the market sends the shares higher in the medium-term, or whether possible investors shy away at the valuation.

Upon admission to trading, DX's CEO Petar Cvetkovic commented, "We are delighted to launch as a public company today, and we are particularly pleased with the strong show of support from institutional investors, which is testament to our future prospects".

That comment was verified by the released major shareholder list post-IPO. There is substantial institutional backing, which includes Henderson, Cazenove, Hargreave Hale and Standard Life to name a few. Well over 50% of the share capital is owned by high-profile investor funds such as these, which is encouraging, although the true test will be whether or not they dispose of their holdings in due course. The chances are that most of them won't and that actually there are still some institutions looking to get in - after all the IPO was oversubscribed, and the private investor element had to be scaled back dramatically. Testament to that, Schroders have subsequently taken a 9.5% stake in the company, probably off of other institutions, and that will have contributed to the relative stability experienced over most of the two days of trading so far. Nonetheless, it is a sign that Schroders (at least) see the current share price as an attractive opportunity. The flip side to the coin is that the private equity investors and institutions in DX prior to listing, wanted to exit their investment hence part of the reason for the IPO. The obvious question to ask is, why now? At admission, directors held 2.26% of the shares in issue.

DX is an independent mail and parcels delivery operator in the UK and Ireland, with similar operations to those of competitors including FedEx, ParcelForce or UK Mail. DX delivers both letters and parcels on behalf of businesses and consumers, and last year they delivered 170 million items. That milestone comes after a stark turnaround and business restructuring by the current management team who were assembled in 2010. Headed by CEO Petar Cvetkovic (who previously headed Target Express and has been the Managing Director of City Link), the company completed several strategic acquisitions, and the IPO marks yet another change in the pace of expansion as there has been an influx of new funds.

To set itself apart in what is a highly competitive sector, DX has focused on protectable niches where there is less room for competition. That is shown by DX's acquisition of Nightfreight, which has subsequently been re-branded to DX Freight. At the time of the acquisition, Nightfreight was an undercapitalised and 'poorly performing' business that specialised in the express delivery of awkwardly sized packages. Nightfreight was bought due to the turnaround opportunity it presented, for synergies, and for the inherent net asset value within.

DX currently operates as a number of business segments in three separate areas, mail and packets (1, 2 and 3), Parcels and Freight (4, 5 and 6) and Logistics (7). Its customers include a number of blue chip clients including HSBC and Johnson & Johnson.
1. DX Exchange = Private Business2Business (B2B) mail and packets, up to 25 kgs
2. DX Mail = Low cost, 2nd class mail equivalent for smaller volume users
3. DX Secure = Operates in the Business2Consumer (B2C) retail parcels market. An example is that they are the distributor of passports in the UK with the HM Passport Office in a contract that runs through to July 2015
4. DX Courier Tracked = B2B next-day parcel delivery with a strong current backing by pharmaceuticals and gambling industries
5. DX Freight = Predominantly B2B. Express delivery of irregular dimension and weight packages
6. DX 2-Man = B2C for heavier items (up to 150kg)
7. DX Logistics = Outsource provider for logistics services such as the provision of liveried fleet. Customers include B&Q.

For the top 5 revenue streams: 30% of revenues are made through DX Freight, 23% from DX Exchange, 14% through DX Courier, 14% from DX Secure and 9% from DX 2-Man. That weighting is very important because of the state of the market and the various challenges experienced. The letters market is in decline (albeit slowing in percentage terms), due to increasing e-substitution whereby online communication methods are replacing those in paper form. On the other hand, the market for parcels delivery is growing due to increasing online spending, and that is an effect seen across the industry. In their last Interim Management Statement, UK Mail said: "Volume growth in the third quarter was again partly driven by an increase in internet shopping related home deliveries, which resulted in a continuation of the mix change towards B2C that we saw in the first half." Revenues from their Mail division declined.

Nevertheless, the parcels side of the market is highly competitive and DX's segment weighting is important both in absolute terms (the state of the market), and in relative terms (compared to other businesses). In absolute terms, DX has lower exposure to the letters side of the business compared to both UK Mail and Royal Mail (both over 50% exposure), and inversely that means that DX has a higher proportion of total revenues exposed to the higher growth parcels business (75% for DX). For that reason, DX expects that any decline in letters will be offset by the rise in the parcels side of the business, specifically DX Freight. Along with a specialisation in next-day/express delivery, DX have been able to cut a niche based on DX Freight in the irregular dimension/weight parcels business and that should protect the group against some of the competition. The backdrop therefore remains fairly favourable, and continued economics growth in the UK sets the scene for an improved industry performance. The parcel delivery element of the industry is estimated to grow at 3.8% per annum.

Looking forward, the strategy is to grow organically and target efficiency improvements at DX Freight where management claim that work is still to be done. The group's property portfolio will also continue to be rationalised - there are currently 76 locations, and the intention is to cut back on this number and integrate multiple hubs where possible. There has been tangible turnaround progress since 2010 already with strong revenue growth and features such as near real-time tracking being made available to customers. Debtor days have also been slashed. The main financial growth can be seen in the table on the right, although that doesn't completely reflect the bottom-line.

The actual profit figures are highly skewed by a number of accounting treatments, which does not make them particularly useful. In short though, profits have been highly damaged by large financing costs in the form of interest repayments. The results to the end of June 2013 showed borrowings stood at a staggering £247.6m and that comes at a huge cost as it eats away at cash flows. The net proceeds of the IPO (£177.25m) will have substantially reduced that figure, but a large chunk of debt will remain on the balance sheet and for that reason DX is unlikely to attract a premium share price rating. Alongside the IPO, new senior debt facilities of £18m were arranged, with £10m drawn on admission. The combined use of these funds are set to reducing gearing to circa 1x EBITDA which is a much improved position, although it still remains a lingering issue in the background. Those issues were not helped by the fact that pre-IPO, total assets were exceeded by total liabilities and most of the assets were intangibles and goodwill, so of little real value. That aside, the balance sheet should now be bolstered and be in a better shape. As at the end of June, there was £30.2m of cash on the balance sheet and net receivables of £12.6m. Cash generation from operations stood at £28.9m

In the six months to December 2013, the group booked turnover of £156.1m and EBITDA of £14.2m, which was in line with the last comparator period. Revenues and profits in the second half of the year are traditionally greater due to seasonality of the business driven by Christmas spending.

Broker estimates for 2014 are for revenues around £315m amounting to around 6% growth. Normalised EPS is estimated to come in around 10.2p (by Edison) with a 1p dividend. Edison also estimate that revenue will rise to £323m in 2015, which would make EPS of 11p and they are also estimating a dividend hike to 6p, reflecting management's plan to pay healthy dividends going forward. For now, I reckon it is not worth looking all the way ahead to 2015 given that it is a new issue, and many things can change, but it is worth keeping the possibility of a ~4.6% (currently) yield for 2015 in the back of your minds. At EPS of 10.2p, DX is trading on 12.7x earnings. That compares with main competitors UK Mail who are trading on a forecast 20.8x 2014 earnings and Royal Mail who are trading on a forecast 14.2x 2014 earnings. Do note though that the 10.2p estimate won't be reported earnings so the market will probably not take it so kindly.

There are of course, other factors to account for. Both UK Mail and Royal Mail have higher prospective dividend yields (in excess of 2.5% vs. DX's 0.8%), but on the other hand, both have greater exposure to the declining letters market. UK Mail does have net cash though and that is a trump card compared to the other two - Royal Mail has a substantial debt pile. Therefore it's worth adjusting in the debt, or out the cash. UK Mail's PER falls to 19.7 and Royal Mail's PER rises to 15.9. Assuming that the entirety of the IPO cash is used to pay off debt (which is unrealistic, but the closest measure), DX's PER rises to around 15.2. So on those figures, DX is not particularly 'cheap' at the current price and arguably the upside is limited. However, the market is valuing IPOs on premium ratings at the moment, and it certainly some sectors are running stretched ratings. I'd even argue that UK Mail's rating itself, is too high and that certain companies within the wider Industrial Transportation sector could be liable to a downwards rating adjustment.

It's always difficult to value an IPO, especially when forecasts are for a dramatic turnaround in fortunes, albeit the basis for that is fairly sound. The broker expectations for DX put the company on a fair valuation in my book given the level of debt held, and at a 15.2x cash adjusted PER, it does not look particularly cheap relative to UK Mail who have net cash, and much better tangible asset backing - the level of goodwill and intangibles carried by DX Group means that investors will have to carry risks associated with potential write-downs.

All of that said, if the company stays at the current valuation and makes good on the 6p dividend expectations for next year, then the dividend yield would undoubtedly attract investors to DX. In the interim, the shares don't look to carry an attractive enough level of upside given the risks, in my opinion, although there is every possibility that the shares could move higher after the IPO, given the current market setting. There probably is long-term value, but that scenario is unclear at the moment and the shares could be vulnerable if there is any short-term market correction. No Rating.


  1. Thanks for flagging this up because it looks like its my sort of thing. I may look to buy on weakness because I agree that the value is not quite exceptional yet. I'd be very happy if I had managed to get in at 100p!


  2. Yeah I would agree that at 130p it looks a little bit high at the moment. Somewhere in the middle of it's current price and the 100p IPO price would be what I consider fair value and where I would be happy to come in at.

  3. Dropped to 128p today so it seems to be easing towards a better entry

  4. Thanks for the write up on DX. I had them on the watchlist too and almost pushed the button on launch day but felt the price was too high given the amount of debt. I think they'll coast downwards for a while as the big guys sell up and take their profits.

  5. Mitesh Patel (chemistdude)10 January 2015 at 09:58

    Could be a decent opportunity at the current share price with city link out of the picture.