An Oversold British Logistics Company With Significant Upside Potential

DX PLC (LSE:DX., Financial) is a leading independent parcel, mail and logistics services company operating throughout the U.K. and Ireland. DX operates under three segments and seven subsegments:

1. Parcels and Freight (52% of sales)
   1. DX 1-Man – Specializes in delivering irregular dimension and weight items. Sixty-three percent of this is Business-to-Business (B2B) although the Business-to-Consumer (B2C) aspect of it is growing as a result of the online shopping trend.
   2. DX Courier – Next day parcel services for the B2B network.
   3. DX 2-Man – B2C home delivery for bulky items (furniture, etc.). Also includes furniture assembly if applicable.
2. Mail and Packets (39% of sales)
   1. DX Exchange – Provides an overnight delivery service primarily to customers in the Legal, Financial and Health care sectors.
   2. DX Secure – Primarily delivers bank and credit card items and has an exclusive contract for Her Majesty's Passport Office (HMPO). HMPO provides passports for British Nationals worldwide and DX delivers those passports across the U.K.
   3. DX Mail – Low cost mail service for smaller volume users.
3. Logistics (9% of sales)
   1. DX Logistics – Provides services from basic warehousing, stock management and delivery to customer-liveried vehicles and uniformed personnel.

(Chart 1) DX (Group) PLC 6 Month Price Chart (Source: Google Finance) Note: Chart Price is in British Pence.

What happened?

On Nov. 13, 2015, DX Group released an update. Management said that sales for the first four months of FY 2016 are down by 5.3%, the DX Exchange subsegment is experiencing a higher level of volume erosion than expected. The volume erosion is being caused by electronic/online alternatives. The stock fell off a cliff.. Literally. A staggering 73% drop in one day (Chart 1).

Driver shortages, an industrywide problem, is also creating cost headwinds for DX. The shortage is a derivative of the aging demographic of U.K. truck drivers; older drivers have been retiring, and the trucking industry has not been able to replace them. According to Milestoneops, a website that advertises and provides staffing services for the Logistics and Transportation Industry, new entrants to the driving workforce have dropped from a record high of 48,227 in 2005 to a low of 25,000 in 2012 – almost a 50% fall.

According to a study done by the U.K. Parliament, only 2% of Large Goods Vehicle (LGV) (defined as vehicles weighing 3,500 kg / 7,716 lbs or more) drivers are below the age of 25, and 60% of them are above the age of 45. The new European Union Certificate of Professional Competence (CPC) standard for LGV drivers has contributed to the shortage woes. It requires all LGV drives to now obtain the new CPC certification, which requires 35 hours of training and costs upward of £500. Those who do not get licensed and are caught driving will be fined £1,000.

The deadline for this was September 2014. This has created an entry barrier because younger folks who actually have an interest in the industry have to come up with the exorbitant certification fee, which they most likely do not have, and so they end up doing something else. Also, those in the aging demographic are likely to call an early retirement, further crippling an already crippled industry.

Outlook

The company is rolling out its OneDX integration and development plan. The plan is to consolidate the operations of the three major segments to drive efficiency and cut costs. This includes the acquisition of the site as well as development costs at an estimated total cost of £35 million which will be funded through operating cash flows and the revolving credit facility. The expenditures are expected to drive a conservative £4 million in savings per annum starting 2018.

The outlook on operations is rather bland. The driver shortage woes are likely to continue in the near term, since it is partially the result of an unproductive government regulation. Management already mentioned that Sales, on a comparable basis, were down 5.3% for the first four months. Full year revenues last year came in at £298 million.

Catalysts/Valuation

Free cash flow machine at current prices

DX Group generated £27.7 million in Cash Flows From Operations (CFFO) last year. Management does not break down maintenance and growth CapEx, total CapEx came in at £9.9 million, and depreciation came in at £8.4 million. Free cash flow, assuming the higher 9.9 CapEx number came in at £17.7 million. Free cash flow of £17.7 million for a company with an enterprise value of £41 million or 2.3x EV/FCF ratio is not too shabby. That number does not even include the extra £4 million from the OneDX integration that we expect to see come 2018. With that added in, DX trades at a staggering EV/FCF of 1.89.

Dividend

Management paid out £0.06 in dividends this calendar year. The dividends were paid when the stock was still trading at the £0.80 to £0.90 range. It trades at £0.20 right now, and those dividends would represent a 30% dividend yield at today's prices. Management only expects to pay £0.025 in dividends next year, which is still ~12.5%. When the transition to OneDX is over, the dividend payout will most likely increase.

Employee stock options

The company issued about 5.8 million shares or about 2.9% of the outstanding shares (200 million outstanding) to management in the form of stock options. The average exercise price for these options is £0.95, or about a 375% upside from the current price. This means that management has every incentive to get the stock price back to £0.95; otherwise, it will never be able to sell them.

Relative Valuation

DX clearly trades at a substantial discount to its competitors;Â 200% upside from current prices would put the EBITDA multiple at 3.75, which is still conservative. DX will make up 7% of my portfolio.

Note 1:Â All figures listed are in Pound Sterlings (GBP), unless otherwise noted. Also, the price shown on Google Finance is in Pence and not Pounds. 1 Pound (£) = 100 pence.

Note 2: I published this article on my website on Dec. 21, 2015. Any dates in this article refer to that period.

Real Time price: [stock_quote symbol="LON:DX" show="symbol" zero="" minus="" plus="" nolink="" class=""] (This price is in Pence, so divide it by 100)