Gati: Weak links in the chain

Listed logistics companies had a good run on expectations that GST would benefit organised players, robust GDP growth would drive demand and higher e-commerce penetration will aid growth. The expectations however may have run much ahead of ground reality.

A case in point is Gati, an integrated logistics player offering express distribution (surface, air and rail), supply chain and cold chain solutions, as well as freight forwarding. The company is among the top five e-logistics players in the country. Gati’s earnings contracted 20 per cent in 2016-17, compared to a year ago. Yet, its stock price has increased 15 per cent in the past year.

Lower earnings and rise in the stock price have made the stock very expensive. At the current price of ₹138, Gati trades at 41 times its trailing 12-month earnings. The current valuation is far higher than its three-year average earnings multiple of 31 times.

There are also equity dilution concerns from the company’s foreign currency convertible bonds (FCCBs). Investors can sell their holdings, given the stock’s high valuation, likely de-rating due to falling revenue growth, profit concerns, equity dilution from FCCB conversion and price correction risk due to high promoter pledging.

Gati has a fleet of over 5,000 vehicles and has partnered with over 600 trucking service providers.

The company’s revenue has been nearly flat since 2014-15. In 2016-17, consolidated revenue increased a mere 1.4 per cent year-on-year to ₹1,691 crore. In the March 2017 quarter, revenue fell 2.5 per cent quarter-on-quarter and 3 per cent year-on-year to ₹415 crore.

Dip in revenue and growth concerns are broad-based and not limited to a few segments. The company’s standalone revenue includes e-commerce, fuel stations (which covers fuel stations dealing in petrol, diesel and lubricants) and freight forwarding. Standalone revenue contracted 4 per cent y-o-y to ₹122 crore.

The fall in e-commerce revenues is a cause for concern as it is a high growth, high margin segment. Revenue was doubling year-on-year in the last two years.

Revenue from its joint venture Keinetsu World Express (KWE), , which contributes two-third of the overall revenue, continues to be weak. The segment offers premium air cargo, express surface cargo, rail transport, supply-chain and warehousing solutions. Revenue fell 8 per cent to ₹265 crore in the March 2017 quarter. The management indicated that there is higher competition in the air cargo segment. The situation may not improve in the near term.

Cold storage division, Kausar, also witnessed 13 per cent fall in revenue to ₹10.4 crore in the March quarter. The company operates about 180 reefer trucks and cold chain warehousing facilities that caters to various industries including pharma and food service. Gati’s profit has been on a decline over the last three years.

Pre-tax profit (before extra-ordinary items) declined to ₹50 crore in 2016-17. This is after falling to ₹65 crore in 2015-16 from ₹79 crore in 2014-15. In the March 2017 quarter, profit plunged over 40 per cent year-on-year to ₹14 crore. The fall in profit is in spite of foreign exchange gain of ₹7 crore.

A reason for low profits is the fall in revenue share of the high-margin e-commerce business. In this segment, profits may not improve in a hurry as there may be pricing pressure.

Net profit in 2016-17 was ₹29.5 crore, down 20 per cent y-o-y. Profit margin is thin, at under 2 per cent and has been on a downtrend in the last two years. The company plans to add warehousing and e-commerce fulfilment centres. While the investments may add to revenue and profit in the long term, near-term margins may be impacted.

Even if revenue and profit improve, the per share earnings may fall due to equity dilution overhang. The company had issued FCCBs for $22 million, due for repayment in December 2016, with a conversion option (at ₹38.5 a share). The bondholders have been wanting to convert these bonds into equity while Gati wants to repay debt.

Last week, the company and bondholders resolved to settle the dispute by entering into an agreement. According to this, 7,528 units of FCCBs will be redeemed; 7,373 units will be converted into equity shares. The balance 7,281 will be either redeemed or converted into fully paid equity shares of Gati at the discretion of the bondholders.

The resolution is a positive and redeeming at least a portion of the FCCBs rather than converting entire units to equity is a plus. Still, if the bondholders choose to convert the optional portion as well (which is likely, given the low conversion price), there could be equity dilution of 17 per cent.

Another concern is the high levels of promoter pledging — over 81 per cent of promoter holding as of March 2017. Pledging has been at over 80 per cent levels in the past one year.

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