ksc valuation?, page-28

Hi sMiRK

I have taken the attitude that KSC can sustain a fully franked dividend of 13 cents for yeara, and hence the price I paid to buy 10,000 on Monday represents a yield of ($0.13/$1.89)/.7 = 9.83%. At that return, I can wait for years, provided the business does not deteriorate in the long term. I am gambling that the business will at least stay flat – an improvement would be a bonus.

On the matter of exposure, KSC has been around for nearly 70 years, and its recent years' performance shows that it can handle economic cycles, albeit with temporary negative blips. Had I not already owned KSC, I might have bought something else, but I do not want to be too diverse (I hold 16 stocks now).

EPS and DPS may turn out worse than my basis for buying into KSC, but I think that on balance things are more likely to turn out better, so I am relaxed about that gamble. It is just below 5% of my share portfolio, and hence it is not a risk that is going to cause me intolerable grief if I am wrong, and for the same reason its small size and low liquidity is not a significant problem either – I can sell something else if I need to find cash.

In summary, the 1H2013 presentation tells us that east coast business remains subdued, which is as things have been since 2009, and the WA business is doing well, and is expected to have a better 2H2013 than 1H2013. The relative improvement of the bottom line to revenue can be attributed to growth in the higher margin WA business, plus the extraction of synergies from the merger of the two WA businesses acquired in calendar year 2010, Regal Transport and Pacific Transport into Regal Transport. The following bullet points come from the 1H2013 presentation:

• Revenue growth of 8% to $293.5 million
• Profit after tax increases by 37.2%
• Strong performance by Western Australian business
• Increased volume with CHEP
• Organic growth in Steel Business
• Balance Sheet remains in a strong position with gearing at 21.8%
• East Coast operations continue to experience the effects of the high A$ East Coast operations continue to experience the effects of the high A$.
• On the West Coast we have seen the positive impacts of the mining industry.
• Our strong first half performance has been underpinned by the strength of our Western Australian operation and the better performance of our East Coast contract distribution business.
• We still have a number of challenges in our East Coast linehaul business due to the depressed volumes.
• Economic trading conditions for our East Coast customers continued to be subdued in the first half.
• In Western Australia where Regal Transport enjoyed solid 32% revenue growth enjoyed solid 32% revenue growth based on mining expansion in the Pilbara and Kimberley regions.
• With the acquisition of Bunbury based Collare Transport we expect to see further improvement in our timber business improvement in our timber business.
• Our Western Australian business looks set to experience growth in the second half.
• K&S is well placed with a strong Balance Sheet, low gearing and secure customer contracts.

The presentation does not prognosticate beyond 2H2013. I think the east coast business will improve as KSC adjusts to the situation there, and for the want of knowing the WA business well, I have assumed it will flatten as mining exploration scales back and miners try to negotiate lower prices to reduce their costs. Synergies probably remain to be extracted in the WA timber-hauling businesses, because the Collare Transport acquisition (announced 31 October 2012) is relatively new, so the business combined with the similar timber-hauling business, Brookes Transport, has not had time to settle down. Both are in the South West of WA. With its origins being in Mount Gambier, KSC has been in the timber-hauling business for decades, so the two WA acquisitions are a good fit.

KSC tends to pay an equal sized dividend each half, but it reduced the final dividend in 2009 to accommodate a sudden deterioration of the east coast business, and in 2011 management went the other way to reflect improvement. The dividend for 2013 could be 13 cents if the final dividend simply doubles up on the interim dividend of 6.5 cents, but if things are looking OK, I suspect KSC will increase the final dividend to 7.5 cents to get to a total of 14 cents, which is better than the 13 cents that I used to justify buying a further 10,000 shares. Dividend history is:

- - - - - - 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Interim - - 5 - -- 7 - -- 7 - -- 7- - - 8 - -- 5 - -- 7 - -- 5 - - 6 - - 6.5
Final - -- - 5 - -- 7 - -- 7 - -- 7- - - 8 - -- 7 - -- 7 - -- 5 - - 5

I have used the same flat-at-worst logic to buy into MND and NWH recently.

My intuitive feel for the WA business was that it would decline as the minerals and energy sector switched from construction to production, but some aspect of the report at http://www.cmewa.com/UserDir/CMEPublications/State%20Growth%20Outlook%20full%20report447.pdf suggested this may not be the case. Look at 6.2.3 Roads and 6.2.5 Social Infrastructure.

The main mineral to consider is iron ore, because that is the game wherein Regency Transport has its main play. Iron ore volumes are scheduled to increase and hence operations workforce. The volumes require improved ports, so billions are going to be spent on the half dozen iron ore export ports. Larger items are required to be transported to producing mines relative to the exploration phase, so large-load trucking is increasing. Roads need to be improved to handle the large loads – more construction. More iron ore volume means more royalties, which means more can be spent on road infrastructure pursuant to the Royalties-for-Regions Programme. More operations employees relative to construction employees tends to require more workers and families living in the area, and less FIFO, which requires housing and other town facilities to be built, which means more construction, and hence more stuff to transport.

It would be instructive to look at the Regional Freight Transport Network Plan currently being finalised by the Department of Transport, but I do not think it has been published yet – publication slated for May 2013. I would be surprised if it is not bullish from KSC's perspective.

KSC's next dividend announcement should allow us to guess how positive management is.