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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Freightways<br>Earnings Delta Symptomatic of Omicron&nbsp;</h2>
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<p><strong>NEUTRAL</strong></p>
<p>We downgrade Freightways (FRE) to NEUTRAL from OUTPERFORM following strong relative performance and as growing earnings headwinds (more challenging macro and the reversal of some COVID-19 gains) dampen the near term outlook. We still expect above average earnings growth over the medium term as FRE's operational and strategic (including scope for accretive M&amp;A) levers leave it well positioned. Trading in-line with the market median at ~19x one year forward PE, FRE offers reasonable value for above average quality and growth. However, sentiment is no longer supportive.&nbsp;</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>EBITA</strong>:&nbsp;FY22 falls -4% from&nbsp;full Omicron hit and higher cost inflation; similar hits in FY23/FY24 as macro headwinds strengthen&nbsp;</li>
<li><strong>Target price</strong>:&nbsp;&nbsp;Lowered to NZ$12.75 from NZ$13.30&nbsp;</li>
<li><strong>Rating</strong>:&nbsp;Downgraded to NEUTRAL from OUTPERFORM</li>
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<h3>Omicron impact outlined</h3>
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<p>The Omicron outbreak through March/April resulted in a NZ$5–7m profit hit from higher operating costs and lower volumes. ~1,000 FRE team members had to isolate for at least seven days, adding significant cost from the increased temporary labour. Absenteeism has now largely abated. The company's update provides the isolated profit impact of Omicron on its operations with no reference to current market earnings expectations. In light of FRE's resilient performance through COVID-19 to-date, we assume that FY22 consensus earnings incorporates very little of the financial cost to FRE. Consequently, we expect consensus downgrades.&nbsp;</p>
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<h3>Express Package volume declines; B2C market likely to give back some of its COVID-19 gains</h3>
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<p>FRE's network parcel volumes declined -2% through March and April reflecting (1) lower customer demand due to their absenteeism,&nbsp; (2) a two week period where NZ Couriers limited pick-up volumes in Auckland, and (3) a slower underlying growth environment as ecommerce growth slows against strong prior year comparatives. Lower ecommerce demand has been illustrated in other markets internationally once COVID-19 restrictions ease. While B2C (business-to-consumer) represents a key growth driver for FRE, it represents ~24% of network volumes, so any decline will likely remove growth rather than materially dent overall network volumes.&nbsp;</p>
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<h3>Cost pain through 4Q22; pricing offset to come&nbsp;</h3>
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<p>Industry cost growth has accelerated materially. A&nbsp;tight labour market and minimum wage increases are lifting average pay rates for lower skilled roles.&nbsp;FRE will likely absorb some of these increases through 4Q22, but plans to action a material price increase on 1 July 2022, which should offset margin pressure through FY23. Previously management has suggested that it would levy a price increase of &gt;+6%. We expect a gross increase of ~+8%.&nbsp;</p>
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Freightways Earnings Delta Symptomatic of Omicron&nbsp;

NEUTRAL
We downgrade Freightways (FRE) to NEUTRAL from OUTPERFORM following strong relative performance and as growing earnings headwinds (more challenging macro and the reversal of some COVID-19 gains) dampen the near term outlook. We still expect above average earnings growth over the medium term as FRE's operational and strategic (including scope for accretive M&amp;A) levers leave it well positioned. Trading in-line with the market median at ~19x one year forward PE, FRE offers reasonable value for above average quality and growth. However, sentiment is no longer supportive.&nbsp;


What's changed?&nbsp;



EBITA:&nbsp;FY22 falls -4% from&nbsp;full Omicron hit and higher cost inflation; similar hits in FY23/FY24 as macro headwinds strengthen&nbsp;
Target price:&nbsp;&nbsp;Lowered to NZ$12.75 from NZ$13.30&nbsp;
Rating:&nbsp;Downgraded to NEUTRAL from OUTPERFORM



Omicron impact outlined


The Omicron outbreak through March/April resulted in a NZ$5–7m profit hit from higher operating costs and lower volumes. ~1,000 FRE team members had to isolate for at least seven days, adding significant cost from the increased temporary labour. Absenteeism has now largely abated. The company's update provides the isolated profit impact of Omicron on its operations with no reference to current market earnings expectations. In light of FRE's resilient performance through COVID-19 to-date, we assume that FY22 consensus earnings incorporates very little of the financial cost to FRE. Consequently, we expect consensus downgrades.&nbsp;


Express Package volume declines; B2C market likely to give back some of its COVID-19 gains


FRE's network parcel volumes declined -2% through March and April reflecting (1) lower customer demand due to their absenteeism,&nbsp; (2) a two week period where NZ Couriers limited pick-up volumes in Auckland, and (3) a slower underlying growth environment as ecommerce growth slows against strong prior year comparatives. Lower ecommerce demand has been illustrated in other markets internationally once COVID-19 restrictions ease. While B2C (business-to-consumer) represents a key growth driver for FRE, it represents ~24% of network volumes, so any decline will likely remove growth rather than materially dent overall network volumes.&nbsp;


Cost pain through 4Q22; pricing offset to come&nbsp;


Industry cost growth has accelerated materially. A&nbsp;tight labour market and minimum wage increases are lifting average pay rates for lower skilled roles.&nbsp;FRE will likely absorb some of these increases through 4Q22, but plans to action a material price increase on 1 July 2022, which should offset margin pressure through FY23. Previously management has suggested that it would levy a price increase of &gt;+6%. We expect a gross increase of ~+8%.&nbsp;


Freightways: Earnings Delta Symptomatic of Omicron

Freightways Ltd

Freightways: Earnings Delta Symptomatic of Omicron