Description

Investment viewpoint: 

CTT is a conglomerate of four divisions operating primarily in Portugal which has been avoided by investors due to their highest revenue mail segment being in sustained decline. After exiting my Aimia position at a 30% loss, I’ve decided to go in for round 2 of the SOTP discount value play. Fortunately this isn’t another value trap run by a dodgy management team , I already see management taking steps to return capital to shareholders and I have full faith in the allignment and integrity of management alongside numerous catalysts to correct the stock’s undervaluation. The growth characteristics of their express and parcel business and their bank have been completely overlooked because of the company still being mistakenly perceived as only a sleepy , low-margin mail business with rapidly declining revenue. In addition, their mail segment has a generous pricing formula locked in until 2028 and their financial services and retail business is accelerating sales of new products. As a small-cap Portugese conglomerate, institutional appetite is minimal and retail investors clearly don’t appreciate the hidden value inside this conglomerate and the actions being taken to ensure shareholders are remunerated.

Background: 

CTT is a prominent Portugese institution with a history of more than 500 years and a nationally recognised brand. In December 2013 it began its life as a public company as the Portugese government sought to fulfil the EU requirements for their bailout. At the time of IPO, the vast majority of the company’s revenue and profits came from their mail division. Over the years, this mail business has fallen from 74% to 51% revenue weighting and a 71% EBITDA weighting to a mere 40% EBITDA weighting and an even lower 17% weighting of recurring EBIT. As mail industry dynamics have caused a prolonged and continuing decline in CTT’s legacy business, their 3 other businesses are all growing including Banco CTT, which was created in 2015 and has grown in to a meaningful and growing bank with €2.7 billion in deposits. Share price performance has been negative over their ten year lifespan as a public entity which is unsurprising given the fall in profits over this period as the mail business’ decline has outweighed the growth of their other segments. I believe public markets are also concerned the business is too closely entwined with government but this is in reality not the case.

Mail and Business solutions: 

CTT runs the national postal operator and I believe that this being their highest-revenue segment has marred the undervaluation of the business and left investors viewing the whole business as in structural decline and hence deserving of what I view as a glaring undervaluation. 

The mail business is a regulated monopoly operating through 569 post offices and 1802 postal agencies. This business has been derisked by the pricing formula until 2028 but must comply with specified conditions over route density and service quality. The business solutions part of the segment offers services including document management, mail rooms and mail for businesses and comprised 15% of the segment’s 2022 revenues.

Despite having experienced a 5% annualised mail volume decline since IPO, this segment still makes up 51% of consolidated revenues and an 17% of EBIT. It can't be denied that volumes will keep declining as they have done at a 5% annualised rate since IPO and are 66% lower than their peak levels in 2001 with an 8% YTD decline in addressed mail volumes which is uncharacteristically worse than management’s typically cautious guidance. However, increased pricing will help to counteract the volume decline’s effect on revenue and profitability. Their current concession service pricing contract lasts until 2028 that uses a formula allowing for inflation pas-throughs and offsets of their volume decline. For 2022-23, the price increase was 6.8% and in 2023-24, it will rise to a 9.5% rise. In fact, ignoring exceptional items, the segment grew has grown revenues 0.8% YTD. Over the last 10 years, revenues have only fallen at a 2% rate despite much greater losses in volumes as a result of increased average pricing. 

There is no denying that profits are falling and this is reflected in the low multiple I ascribe to the segment in spite of the new concession contract with generous price increases. EBIT has fallen from €43m in 2019 to €11m in 2022 with margins going from 8.8% to 2.4%.

A bright spark is management’s cost-cutting efforts in this segment and which will bring some recovery from the anaemia current margins. In fact, there is guidance of staff reductions leading to a midpoint of €5.25m of EBIT improvement on top of €2.5m of EBIT improvements from a reduction in headcount of 83 YTD which incurred termination costs of ~€3million. CTT hasn’t broken out what portion of the €2.5m of EBIT improvements from headcount reduction have increased 2023 EBIT but I conservatively model only €1m of this €2.5m will affect 2024 EBIT, hence assuming most of the cost reductions flowed through to 2023 EBIT even though headcount reductions were only first mentioned in the Q2 earnings call implying they have mainly occurred in the back end of the year. As such, I see €6.25m of EBIT improvements from cost reductions by 2025. I believe 2022 EBIT is a fair base for my model given generous price increases with the most recent price increases 1.5pps above their YTD volume decline. As such, I see €17.25m of EBIT by 2025.

Banco CTT: 

Banco CTT’s growth can’t be understated as they have grown from zero to 637000 current accounts in 8 years and in the process building a €2.7 billion deposit base. They leverage the CTT post office network by having bank branches in 212 of these post offices. There is a 36%, 43%, 20%, 1% mix of loans by value between mortgage loans, auto loans, credit cards and leasings/overdrafts respectively.

The underwriting standards of the bank are respectable but less stringent than more established banks given the strong emphasis on growth. Over the last five years, NPL ratio has averaged 4.8% and has increased from 3.4% in 2018 to 5.1% in 2022 in spite of the Portugal banking sector’s NPL ratio significantly falling in this period. This is partly attributable to their credit card portfolio growth which was started in 2019. With an NPL ratio currently 60% higher than the Portuguese banking system, asset quality seems questionable, but I believe this isn’t actually the case. Given growth to 1.8 billion in loans since inception in 2015, slightly lower credit quality is not alarming and with the exit of the Universo Credit partnership in December 2023 management has stated non-performing exposures will decline and excluding the credit card portfolio cost of risk stands at a respectable 0.7%. Additionally, the bank has a very healthy 15.6% CET1 ratio which will grow to 24% with the imminent completion of the Generali partnership and the end of the Universo credit card partnership. This excess of capital will naturally decrease as the consumer credit portfolio grows from €1.55 billion to somewhere around €2 billion in 2025(management guidance).

In Q4 2022, CTT announced a new insurance distribution agreement with Generali which included a €25 million share capital increase for a 8.7% stake in the bank at a €287m valuation.. Generali will pay CTT €10 million over the 6 years along with contingent compensation depending on the partnership’s performance. In my view, this demonstrates the value of the post office network that CTT has. Combined with the reputation as a trusted entity for over 500 years, the optionality of their network can’t be understated. I view the bank’s financial strength as nothing to write home about but nothing to be fearful about and the bank’s strong capital ratio allays our concerns to a high degree.

Given that Banco CTT only has branches in 37% of CTT post offices, the bank has scaled quickly and can continue to do so with high incremental margins as shown by CIR falling from 71% in 1Q22 to 63% in 2Q23 with negligible NIM change, which, no surprise, sets them in great stead to reach their 2025 CIR projection of 60%. It is of note that the bank has grown their consumer credit portfolio from €1.1 billion in 2021 to €1.8 billion in Q3 2023, eclipsing their CMD guidance of €1.7 billion by 2025 over a year earlier which highlights management’s conservative guidance and continued execution.

As evidenced above, I believe management is executing very well. CEO Luis Coutinho has vast industry experience and is still spearheading the company’s market share growth and ensuring customer satisfaction as well as successfully digitising the bank with over half of customers using the bank’s digital channels. This has led to their NPS consistently over 40 alongside achieving a 74% satisfaction rate in their banking business. It is of note that CTT increased deposits 6% in 1H23 while markets lost 4% of deposits on average while at the same time boasting encouraging quality and customer service metrics. Given the continued execution and beating of guidance as well as targeting the estimated half of customers that are not fully penetrated, I view 2025 profit before tax targets of €25-30 million as achievable driven by guidance of a reasonable 11-13% ROTE as revenue grows and loan losses decline with the termination of the Universo partnership and improved assuming a tax rate of 21%, this could mean €21.7 million of net income. If I apply a very conservative 10x PE for a bank that is gaining share and growing rapidly, this would imply a 0.9x P/BV multiple which we still think is conservative yet much higher than analyst modelling of a 0.6 to 0.7x P/BV.

Express and Parcels:

CTT’s express and parcels business has only made up 18% of recurring EBIT and 32% of revenue YTD, which we believe has caused public markets to not fully appreciate the growth prospects of this business driven by structural tailwinds in Spain and Portugal e-commerce penetration as well as the integration of this segment with the mail segment. Data is surprisingly difficult to find on the express and parcel industry but in 2022, Portugal parcels per capita were 1/6 of the UK number.Moreover in 2021, Portugal’s parcel penetration was a dire 16% of the average of the top 5 shipping market’s penetration and with Spain’s e-commerce penetration being a measly 46% of the 5 largest shipping markets’ average penetration. Iberia is expected to be the largest growing e-commerce market in the coming years.

The express and parcel operations are run by Manuel Molins who took SEUR and turned it into the leader in package shipments in Spain and then was brought in by CTT after the Spanish government added a number of government employees to the management team. Portugal revenues have grown from €98.2m in 2019 to €132.2m in 2022 (10% CAGR) with and have seen 12.6% YoY growth YTD. Spain revenues have grown from €51.8m to €123 million in 2022 (33% CAGR) and have seen further 32.2% YTD in 2023. This has led to EBIT growing from -€0.5m to €8.5m and 9m23 EBIT of €12m. He has overseen impressive 14.6% annualised volume growth from 2019 to 2022 in the Portuguese operations and 35% annualised volume growth in the faster growing Spanish segment which has been completely turned around into a profitable, fast-growing part of the business, doing the opposite of past management and bringing excellent results and not neglecting customer experience with NPSs > 50 consistently. I think Molins runs this business with a long-term and owner-like mindset, for example during the pandemic, profits of the E&P segment were temporarily sacrificed by reducing usage of CTT’s mail network and giving more business to their external delivery partners in order to support their partners’ financial stability and ensure their survival over the pandemic. 

During Molins’ tenure, Spanish E&P EBITDA margins have gone from a trough of -12% in 2020 to a YTD 10.6% margin as well as EBIT margins of 6% in the most recent quarter. Although the Spain business has benefitted from an estimated 40% growth in e-commerce from 2020-23, revenues have trounced this number and market share has been taken by CTT Express. On a LTM basis, the Spain CEP business has generated €12.6m of EBITDA, up significantly from 2019’s €9m EBITDA loss. Most recently, management has guided to improvements in market share from MSD to HSD and a HSD EBIT margin as the business scales and sees fixed cost leverage. 

My model takes into account all of the above as well as 9M23 revenues essentially equal to FY22 revenues even with Q4 being the strongest quarter. CEP Spain is seeing slight negative mix shift with smaller client volumes growing 7% more in Q3 than total volume growth and 15% more in Q2 as well as 62% more in Q1. Additionally, more China e-commerce volumes are a slight headwind to pricing. Given the constant changes in mix and even management’s uncertainty on the rate of customer acquisition, it is very difficult to accurately model future revenue growth which is why I strongly considered management guidance in our growth assumptions and we take comfort in their repeated execution and beating of long-term guidance.

Management has vaguely implied an approximate doubling of market share in Spain by 2025 which merely gives us comfort in our projections. My model accounts for a 22% revenue growth, above 20% guidance given in the 2022 CMD but this is more than justified and still conservative given the above performance and management’s consistent conservative guidance and far below 35% annualised revenues growth from 2019-22 as market share growth begins to slightly moderate. Additionally, we see EBIT margin rising from 6% to 7% accounting for HSD margin guidance and CFO Guy Pachecho stating ‘even some improvement vis-a-vis the quarter in what should be sustainable margins going forward’. As such, we get €16m of EBIT by 2025.

The Portuguese operations are growing at a lower rate as briefly mentioned above with an 18.9% volume growth YTD as compared to the Spanish operations’ 34.4% given new customer wins in the year. Unlike the Spanish side of the business which is almost entirely B2C, in Portugal B2B revenue comprises a far greater portion of their revenue. The Portugal business is integrated with their mail network and as mail volumes keep falling, this integration will only increase. Interestingly, management of the regional networks of the CEP operations and the mail operations are integrated. The company uses a process called the Decision Server to decide which parcels will be delivered by the mail or the CEP network. As a result, EBIT margins in Portugal are higher with management believing they will stabilise around 11% due to the pre-existing synergies with the mail network. Also, unlike the Spain business that is growing in a more penetrated, slower-growth market by taking share aggressively, in Portugal CTT is the market leader and benefiting from a fast-growing e-commerce market. The Portugal operations have generated €19.4m of EBITDA on a LTM basis. We model a 12% annualised revenue growth to 2025, ahead of projected 11% e-commerce market growth given slight improvements in mix as B2C volumes accelerate and reinforcement of their market leader position.As such, we model €20m of EBIT by 2025.

Financial Servives and retail:

The vast majority of revenue and earnings in this segment come from CTT’s agreement with IGCP, the public debt agency to be the sole retail distributor of public savings certificates which continues until January 2026. As such, market share in the business typically runs around 75% with this number growing to around 80% which has coincided with the explosion in the segments volumes as interest rate rises have increased the appeal of these products. Encouragingly, digitazation of their public debt offerings should further drive market share. On top of this, non-banking financial products are a meaningful and fastly growing part of the segment and this line of business includes non-life insurance and health plans. Management has started targeting growth in insurance distribution with 52% of CTT stores in Q3 selling insurance and 95% in Q3, talk about getting the job done! This mirrors prior year commentary of wanting to grow non-banking financial product revenues. 

Public debt securities make up over half of revenue and have recorded YTD revenue growth of 106% this is the result of higher interest rates with volumes and revenue expected to stabilise around these levels. Steps have been taken to digitise the offering and minimise churn after such rapid growth. Additionally the €50,000 ceiling per account was lifted at YE23 and this should provide a small uplift to growth. Nevertheless, management believes public debt placements will stabilise at €1.1 billion per quarter with this number moderately growing to €1.25billion by 2025. In 2022, public debt certificates posted revenues of €33.5m as compared to €22.7m in 2021 due to 86% volume growth. Over only 9 months in 2023, subscriptions are already 51% higher than FY22 subscriptions with revenues up 106% on a YoY basis. This rapid growth will inevitably fade away with subscriptions and revenues returning to a normalised level as appetite for these savings certificates moderates as most savers have now taken advantage of the abrupt rise in interest rates these products offer. 

Management has emphasised their focus on diversifying this segment away from public debt certificates. Insurance products client interactions have grown 33% between Q2 and Q3 and the offering of insurance products are now in essentialy the entire CTT retail network. A HSD portion of the financial services segment revenues also come from money orders but this is a pretty minute part of the business and not a growth driver.

All in all, this segment is a high-margin, key driver of growth for CTT along with the E&P operations It is very difficult to predict with any accuracy the future earnings profile of this segment but we use CMD guidance of EBIT weighting by 2025 as well as the midpoint of group EBIT guidance to reach ~40m of EBIT by 2025. 

CTT has valuable real estate they are monetising:

CTT has a vast network of real estate, both core and non-core that they are optimising with proceeds being returned to shareholders as well as used in capex investments and M&A if deals at attractive multiples can be found. 

The majority of CTT’s real estate footprint is in use by their operations and has been carved in to a SPV called CTT IMO. These assets are part of CTT’s retail and logistics operations and will continue to be used by CTT in future. On January 4 2024, the first phase of selling a stake in this SPV was concluded at a transaction value of €138m for the underlying assets. Gross proceeds from the transaction will amount to €36 million and net proceeds will be around €24m for the sale of a 26.3% final stake to institutional investors, family offices and Sierra Sonae, a real estate business operating across management, investment and development of real estate. Sierra Sonae are an active asset manager that will help growth the value of the portfolio through higher occupancy rates and development initiatives. There is significant room for NOI growth from these properties as they currently have a ~25% vacancy rate which Sierra Sonae’s expertise has been brought in to rectify. Management has expressed the possibility of selling up to 49.9% of this SPV which won’t incur additional tax expense and hence net proceeds will be more material. Additionally, CTT has €50-60m of real estate that won’t be core to future logistics operations and may be offloaded in two to five years. These assets are a mix of land plots, logistic assets and warehouses and prime location buildings. It is clear management are looking to optimise this valuable portfolio and the first phase of proceeds will be reported in their next set of earnings. At current valuations, the SPV should bring in €56m of net cash proceeds and the development assets will by out estimates result in €47m net cash proceeds. In a nutshell, this proactive real estate optimisation scheme by my estimations will lead to €103m net cash proceeds or 19% of their current market cap.

Capital allocation:

I would understand if you have been struck with a feeling of dread and expect me to reveal an entrenched, capital-destructive management team desperate to line their back pockets and chase senseless acquisitions and a focus on anything but the shareholder, I will dispel this faulty yet understandable concern here.

Management has repeatedly put emphasis on shareholder remuneration with a 35-50% dividend policy in place which is their key method of returning capital. Their 3% dividend yield is healthy while preserving sufficient capital for capital expenditures and efficiency improvements including headcount reductions. With the glaring undervaluation of the share price, a lower payout ratio to focus on more buybacks would be especially accretive to shareholders, but we acknowledge that they have paid a dividend every year since their listing and their payout ratio still leaves plenty capital to be used. Alongside a generous dividend policy, CTT is focused on buying back shares with a €20 million buyback in place this year, above the €18m of dividends paid. 

We are very encouraged by management commentary over M&A, this is not a management team that will chase growth at any cost and in multiple earnings calls they have emphasised the possibility of M&A only at attractive multiples. The proof is in the pudding as the last notable acquisition was of 321 Crédito at an 8.5x EBITDA multiple in a lower-interest rate, higher valuation environment as well as providing strategic value to the Banco CTT segment. Other acquisitions include the BPO provider Newspring Services in 2021 for €11m but apart from that there is no recent notable M&A activity. This management team will not squander shareholder value on unprofitable M&A and instead has made clear their focus on investing in growth in CEP as well as cost efficiencies primarily in the mail business. Any M&A activity will likely be in the form of tuck-in acquisitions to support/accelerate growth not acquisition of unrelated businesses at disappointing multiples.

CTT has created a positive work environment while pursuing profit and revenue growth at the helm of a great and incentivised management team :
While I don’t want to digress from the economic merits of a CTT investment, the company culture speaks to managements continued execution and long-term thinking. In December, a labour strike was called and no-one turned up apart from the organisers of the strike. Analysts have completely neglected to mention this fact and the lower staff turnover associated with the culture that has been created. It is difficult to ascribe an economic value to the positive culture created by management. Although 76% of workers are unionised, CTT has not let this materially affect the business with occasional strikes occurring but certainly not concerning. This has been achieved alongside having the best punctuality of deliveries in Portugal as well as impressive NPS scores and customer satisfaction across the business.

We think management execution has been stellar and are encouraged that this is CEO Joao Bento’s third CEO role at a conglomerate and his choice of directors of the different segments can’t be faulted as evidenced by the strong performance of these executives detailed throughout the write-up. These executives are well-aligned due to an option scheme for directors wherein they have each been granted 6 million options* with only 20% of these options in-the-money at the time of writing. If the share price were to rise to €5, each director will see €278,000 of gains assuming sale of the options and €1.9 million of shares rose to €10. These options are to be freely traded and the figures above are merely to represent the alignment of directors but highlight the alignment of management and the resulting owner-like mentality. Despite excellent management execution and their pursuit of new growth levers, compensation is very reasonable. Additionally, 10% of bonus executive compensation is based off NPS, a fantastic idea that likely came from board member Steven Wood. Steven Wood runs GreenWood Investors who hold a 20% stake in CTT as their main holding and he has certainly had a hand in some of the strategic actions of CTT as well as improving investor communication for example with the recent Reverse Roadshow to highlight the value of the bank. While CTT still needs to sort out their IR page that occasionally crashes and and fill in all of the slides of their most recent presentation, for a Portugese small-cap, Investor communication has been strong. We take great comfort in his fund’s excellent track record and have no doubt that a man of his experience and apparent integrity should help catalyse a reduction in CTT’s undervaluation. 

*these options equate to 0.116 shares

Balance sheet :

Net debt stands at €176 million excluding Banco CTT. This comes alongside LTM EBITDA of €107.7m excluding Banco CTT meaning a 1.6x leverage ration. Their guidance of a lower than 2.5x net debt – EBITDA. This provides room for potential M&A and other initiatives e.g. the roll-out of their Locky locker network. CTT’s cash generation more than supports their modest debt levels with an average FC conversion rate of 1.45x between FY20-22. In our view, growth in leverage would almost certainly be accretive if used to purchase shares that seem undervalued on all metrics and are trading at a 20% FCF yield. However, management has countered that this buffer over the leverage ratio provides them with capital to keep growing the business, pursue M&A if attractive targets at low multiples present themselves and continue their shareholder remuneration. Therefore, we merely view CTT’s low leverage as providing further optionality and further proof of long-term, patient management.

Valuation :

Looking at the business on a SOTP basis, undervaluation is glaring. I value the mail operations by 2025 at 4x EBIT which gives €69m of value. We value the bank at 0.9x their equity given the assumptions embedded earlier in the write-up for a €217m value. While E&P Comps are around 10x EV/EBIT, the 16% blended growth we see to 2025 and the potential for more market penetration after that I believe merits a 12x multiple for this segment, similar to where UPS and FedEx trade at, one could argue there deserves to be a Portugal discount but the growth prospects more than compensate for this in my view. Therefore, we arrive at €432m of value for the E&P segment. I attach a 7x multiple to our projection for financial services and retail’s €40m EBIT by 2025, meaning a €280m valuation. On top of this, I ascribe €103m of realisable value to the real estate monetisation scheme. After accounting for €65 million of net debt *All in all, this leads to €1.036 billion of value on a SOTP basis. If we assume that hypothetically the share price instantly rises to this value and buyback allocation remains the same, shares should be worth €7.5 by YE 2025. Also, if one assumes dividends remain the same despite rising profits, there should be €0.25 of further TSR meaning a return of 110% in less than two years.

*this figure doesn’t include finance leases 

Summary:

The reasons for the undervaluation are clear and there exist numerous catalysts for a re-rating of the stock ranging from dividends, buybacks, shift towards their high-growth segments becoming the primary parts of the business and cash coming in from real estate sales. Investors seem to have disregarded the hidden value of the business under the pretence that shareholders won’t reap the benefits of the underlying health of the group. There exists a very high margin of safety and great return potential which in itself greatly limits downside risk which makes for a great investment along with a multitude of catalysts. In a nutshell, this is my highest conviction idea and I really struggle to see a scenario where there isn’t significant stock price appreciation from current levels.

Catalyst

Real estate cash proceeds coming in

Material acceleration of their growth segments becoming apparent on a consolidated basis

Bank profitability accelerating as it reaches scale

Buybacks

E&P profitability inflecting as the segment scales

Generous dividends that will grow alongside profits

2025 targets materialising 

Undervaluation is a catalyst