This article first appeared in The Edge Malaysia Weekly, on January 18 - 24, 2016

MANY in the investing fraternity think that Pos Malaysia Bhd has great growth prospects, if it is able to evolve into a logistics company as planned.

Its major shareholder DRB-Hicom Bhd, which currently holds a 32.2% stake, seems to be trying to do just that. The diversified group, which bought its stake from Khazanah Nasional Bhd in 2011, intends to inject its logistic operations, KL Airport Services Sdn Bhd (KLAS), and a parcel of land into Pos Malaysia for RM835.16 million. In return, the group will be issued with 250.8 million new shares in Pos Malaysia at RM3.33 apiece, subject to share price adjustment. The issuance is expected to raise DRB-Hicom’s equity interest in Pos Malaysia to 54% to 55.6%.

The number of shares issued is equivalent to about 47% of Pos Malaysia’s existing share capital. This would mean massive earnings and shareholding dilution after the acquisition.

The proposal has not gone down well with the market. Pos Malaysia’s share price has been heading south since the announcement of the plan last December, falling to RM2.40 last Friday, the lowest since August 2012. Nonetheless, the selling could also be owing to the current cautious global sentiment.

How good is the logistics business that is being offered to Pos Malaysia? If it is earnings accretive, the postal group should not miss the boat.

KLAS is the country’s only licensed independent operator that provides airport ground handling, cargo handling, inflight catering, as well as aircraft maintenance and engineering services. Its clientele includes inbound and outbound international commercial airlines such as Singapore Airlines, Qatar Airways, KLM, Etihad Airways, Air France and AirAsia. KLAS wholly owns Konsortium Logistik Bhd (KLB), a haulage company that DRB-Hicom took private in 2014.

However, KLAS’s filings with Companies Commission of Malaysia do not show a decent set of financial results.

Despite an increase in revenue to RM530.2 million in financial year ended March 31, 2015 (FY2015), KLAS saw its net profit decline 57% to RM8.3 million, down from RM19.6 million a year ago.

In the last five financial years, KLAS has not declared a dividend and its net annual profits have not exceeded RM21 million (see table). On average, the company reported an annual net profit of RM16.8 million from FY2011 to FY2015.

Moreover, KLAS’s net margin contracted sharply from 10.6% in FY2013 to 1.6% in FY2015 while its net gearing ratio ballooned from 0.5 time to 4.3 times during the same period.

Simply put, it is difficult to see how KLAS could make a sufficient earnings contribution to Pos Malaysia at this juncture to offset the impact of the earnings-per-share (EPS) dilution.

The acquisition might also affect Pos Malaysia’s ability to pay out dividends if it is required to pump in money to expand KLAS’s business.

To recap, Pos Malaysia on Dec 10, 2015, received a conditional offer from its parent company DRB-Hicom to dispose of its entire stake in KLAS for RM766.16 million.

DRB-Hicom also plans to sell its 9.9-acre parcel in Section 28, Pekan Hicom, Selangor, for RM69 million. The freehold industrial land has been approved for the development of 30 semi-detached factories and two detached factories.

Pos Malaysia has been known as a cash-rich and debt-free company over the years. As at Sept 30 last year, the group had cash and cash equivalents of RM658.9 million and was without long-term borrowings. After deducting revolving credit of RM98.8 million, it was sitting on a net cash position of RM560 million, or RM1 per share.

In other words, every share that DRB-Hicom receives will be backed by cash.

However, in terms of earnings, Pos Malaysia’s profit has been on a downward trend in the last two financial years.

The group’s net profit fell 20% to RM127 million in FY2015, down from RM158 million a year ago. This was mainly attributed to rising operating expenses and margin compression in its traditional mail business. Its revenue, however, grew from RM1.43 billion to RM1.49 billion, driven by strong growth in the courier, express and parcel business, which was catalysed by rapidly increasing e-commerce activities.

Pos Malaysia’s net profit continued to slump in the six months ended Sept 30, 2015 (6MFY2016) to RM26 million from RM61 million a year ago. It reported a lower profit from the mail and retail segment, no thanks to higher transportation cost in its transhipment business. For 6MFY2016, the group’s revenue grew from RM740 million to RM789 million.

The board of directors received the offer on Dec 16 last year but the proposed acquisitions are still subject to the approval of shareholders at an extraordinary general meeting that is to be convened.

Other substantial shareholders of Pos Malaysia — including the Employees Provident Fund (11.6%), Kumpulan Wang Persaraan (Diperbadankan) (11.8%), Mitsubishi UFJ Financial Group Inc (7.6%), Aberdeen Asset Management plc (7.5%) and Aberdeen Asset Management Asia Ltd (5.4%) — could be the deal breakers.

In a Dec 11 note, HLIB Research highlights that the acquisition price for KLAS of RM766.16 million indicates an at least 100 times price-earnings ratio valuation. Assuming potential earnings of RM10 million for the financial year ending March 31, 2017 (FY2017) from KLAS, EPS dilution for Pos Malaysia would be 28.4%, it says.

“We are relatively negative on the deal from Pos Malaysia’s point of view, given the high valuation,” the research house says, adding that Pos Malaysia might have to inject capital into KLAS for expansion purposes, which will eventually limit its potential dividend payout.

Meanwhile, in a Dec 14 report, RHB Research analyst Izzat Esa estimates that KLAS needs to generate earnings of RM50 million to RM60 million in FY2017 to avoid any EPS dilution from the potential transaction.

Over the long run, however, the acquisition could create a synergistic relationship between Pos Malaysia’s business segments and diversify its earnings base to mitigate the declining earnings of its traditional mail business, says Izzat.

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