Description

I like Inpost at the current price of EUR 6.40. Inpost listed roughly one year ago at an absurd valuation and will always remain in my mind as an example of the power of fantastic timing & great story telling. After hitting EUR 20, the share price collapsed and Inpost now trades at a much more sensible valuation and I argue that the current set-up is attractive. I’m not a great timer and 2022 will be a relatively weak year for Inpost, but the company provides an interesting offering in an otherwise commoditised market. I believe that as of next year – barring a significant deterioration of the macro environment – Inpost is poised to greatly increase its cash flow generation.

Background

I will not spend much time discussing Inpost’s background; Rialto95 provided a good short-thesis back in December and I highly suggest readers to check it out, as it provides some background on the company as well as a great discussion which (partly) reflects the reason why the share price retracted since IPO. Some of the risks highlighted in Rialto’s write-up are still present and valid, though I argue these are currently more than priced in.

Inpost operates last-mile delivery by providing a network of Automated Parcel Machines (APMs) – lockers which customers can access to pick up their parcels. This delivery option is cheaper for merchants and provides an alternative for customers as to-door delivery might not always be the most convenient option (i.e. parcels arrive at time when customers are not at home).

Inpost’s operations are segmented by geography: Poland, Inpost’s home country, UK & Italy and France.

• Poland has an already relatively mature APM network, with roughly 17k APMs (2.6m lockers), 15m users and 10m active mobile app users. Expansion in Poland continues though at a slower pace compared to recent history, as most of the ‘land grab’ is done and high network density has been reached (>60% of population within 7min walk). All of the company’s cash flow is generated in Poland. This segment is the main value driver over the medium-term as expansion capex will subside and cash flow will continue to ramp.
• UK & Italy are still a long way from having a mature network. Combined, Inpost operates ~4k APMs, mainly in the UK. Inpost does not have the necessary infrastructure and partners with a 3rd party (Hermes) for logistics in the UK. The strategy here is ‘customer education’ as the UK (I ignore Italy given the negligible size) is not an out-of-home (OOH) delivery market and customers need to get accustomed to APMs. Consequently, the focus is on placing APMs on high density footfall locations (e.g. supermarkets). This segment will take a long time to become cash flow positive as much more investment is needed to increase network density and build the necessary infrastructure. The latter will most probably be achieved via an acquisition of logistics partner Hermes; Advent (owner of 46% of Inpost) acquired a 75% stake in Hermes UK in 2020). The UK has long-term potential but I ignore it, as most of the company’s attention is now focussed on the Mondial Relay opportunity.
• Inpost closed the EUR 530m acquisition of Mondial Relay in July 2021. Mondial Relay operates ca. 17k pick-up, drop-off (PUDO) points, mainly in France. I believe the Mondial Relay opportunity is large and currently completely ignored by the market – I elaborate this in greater detail below.

APMs can only be a viable delivery option alternative for merchants and customers provided there’s a proper network density of APMs, including the necessary volumes and logistics (hubs, depots, warehouses, etc.). Creating such a network requires significant investments and it should be no surprise that Inpost to date has generated little to no free cash flow (after lease payments). I believe that is about to change. Poland now has a relatively mature network which should start to generate significant cash flows and the Mondial Relay opportunity is significant.

The opportunity

I’ll start with discussing headwinds the company is facing. These headwinds are real and will impact performance over this year, potentially next year as well. I argue that these headwinds are manageable (unless one assumes a prolonged economic downturn) and that Inpost’s current share price provides an attractive entry point into what I expect should be strongly increasing cash flows over the medium term.

• High interest rates. Interest rates are arguably the company’s greatest risk. Inpost’s IPO date almost bottom-ticked the generational low on Polish interest rates. Since then, interest rates increased rapidly, particularly in Poland where they basically exploded from ca 1% at the IPO date, to almost 7% today. I believe there’s no need to go into the well-known general impact of higher interest rates; higher discount rates, lower consumer spending / confidence given high inflationary pressures, fund flows out of unprofitable / cash burning companies (Inpost at the time of IPO) into value, etc.
  
  
  
  Higher interest rates will certainly impact consumers, particularly Polish consumers, but I am positive nonetheless. The success of Inpost’s proposition boils down to maintaining a proper pricing gap between APM and to-door delivery. APM delivery is ca. 25-30% cheaper compared to to-door and the current inflationary environment is increasing this gap. Every player in the industry is facing strong pressure on margins mainly due to rising wage and fuel costs, combined with an inability to quickly pass higher costs to end-customers. In addition, legacy operators have much less margin leeway (even incl IFRS 16 lease payments) to absorb inflationary pressures. On a per parcel basis, wage and fuel costs are much lower for Inpost compared to all other logistics operators and it will be easier for Inpost to pass (more of) these costs to merchants.
  
  Inflationary pressures will also drive APM adoption; merchants that previously were not even thinking about APM delivery as an option are now looking for ways to maintain margins. Indeed, Inpost noted a strong increase in interest from merchants over the last few quarters.
  
  A headwind is higher interest payments. Mondial Relay’s acquisition added a significant amount of debt to Inpost’s balance sheet, about half of which is floating. Assuming current interest rates levels, I estimate debt servicing costs to increase ca PLN 150m. This will put additional pressure on this year’s FCFE generation, which I estimate to be roughly break-even before debt paydown, but the added expenses are manageable, particularly as of next year when price increases will drop through.
  
  I'll add that in the event war in the Ukraine ceases, it is likely that Polish interest rates will drop. Though not necessary for the thesis, Inpost's share price is likely to pop in such case.

• Competition. The previous point also improves Inpost’s competitive advantage. Inpost clearly enjoyed a first mover advantage. As previously explained, in order to achieve a sustainable business model, significant investments are needed to create a proper network and achieve economies of scale. Many peers were reluctant to invest in an APM network due to cash flow and /or balance sheet limitations. Furthermore, many did not deem APMs a viable option as the focus was on providing and improving to-door delivery. Competition has clearly increased over the past few years, but the gap with Inpost remains large. In Poland, Inpost operates 2x the amount of lockers than the competition combined. Inpost’s success in Poland will certainly attract new players in the future and pressure on prices will become a reality at some point, but it will take a long time before competition reaches a scale to become a threat to Inpost. Many players will need a lot of capital to play catch up, capital which is becoming more expensive by the day. And a previously explained, many peers don’t have the luxury today to engage in multi-year money losing endeavours. Importantly, Inpost has been grabbing the best APM locations and will continue to do so. Even if well capitalised competitors such as Amazon decide to go full-APM (doubt it) they will face the headwind of sub-bar APM locations.
  
  
• Large lease liabilities. Inpost has significant lease expenses directly related to the number of APMs (mainly land, but also warehouses and hubs). Following IFRS 16 standards, lease liabilities are capitalised and amortised over various years. One reason why I believe free cash flow generation will ramp up over the next few years is normalising lease payments. Inpost amortises lease liabilities over ca 3 years. Following an exponential growth in APMs deployed over the past few years (+2700 in 2019, +3900 in 2020 and +8100 in 2021), lease payments will strongly increase and will continue to pressure free cash flow in the medium term. However, APM deployment will slow down of as this year, both on an absolute level as well as relative to sales. Consequently, free cash flow generation should strongly increase as of 2024, once this acceleration of lease payments subsides.
  
  
• Utilisation rates. The above increase in lease payments is manageable – as long as utilisation rates remain healthy. Based on recent indications, utilisation rates are normalising, but they remain at good levels and give confidence to the thesis.
  
  
  
  After a few relatively strong quarters due to covid induced lockdowns, APM utilisation rates have come down. Based on 1Q 22 results, I estimate a current utilisation of ca. 60%. I argue this is a healthy level, taking into account the strong APM growth over recent years (i.c. many APMs still need to ‘mature’) as well as the economic headwinds during Q1; following the war in Ukraine Polish consumer spending dropped strongly during the quarter. I understand from Inpost as well as Allegro that spending levels normalised during March / April and are continuing at healthy levels.
  
  Utilisation levels should increase over the medium term as new APMs mature and APM additions / current APM base decreases. However, even assuming constant utilisation levels would suggest a strong ramp in cash flow generation over the medium term.

Besides the above mentioned, I believe one of the best and most underappreciated opportunities for Inpost is the ‘automation’ of Mondial Relay. As explained, Mondial Relay operates PUDO points. In terms of pricing and quality, Mondial Relay is to be regarded as the ‘discounter’ in last mile delivery. The service is sub-optimal (D+3/4 delivery) but pricing is by far the cheapest. As such, and combined with a market where OOH delivery is 30%, Mondial Relay has been able to attract a relatively large and stable customer base.

The main reasons Inpost failed in its previous international endeavours were APM expansion without investments in the infrastructure and a underestimation of the willingness of consumers to adopt APM delivery. I believe Inpost learned from its failures and with Mondial Relay acquired an asset that greatly fits the company’s strategy. For starters, OOH delivery is prevalent in France and consumers have a relatively high willingness to go leave outside to retrieve their parcels. Also, Inpost acquired an asset with a mature footprint and infrastructure. In addition, the PUDO network will benefit greatly from the conversion to APMs.

Over the short term, Inpost will focus on improving Mondial Relay’s offering, by investing in the infrastructure to provide D+1 delivery. It is reasonable to assume that this will increase customers satisfaction and attract new customers as well. Over the medium and longer term, Inpost will convert PUDO points and introduce APMs. This will greatly improve overall efficiency (parcel capacity).

Valuation

I prefer to value Inpost with a DCF model, given that I expect cash flows to strongly improve over the medium term. As always the inputs are up for discussion but I believe I incorporate a healthy amount of conservatism. I assume some operating leverage over the medium-term but none otherwise. The reason is that although costs per parcel should continue to go down as scale increases, competition might limit / hamper revenue per parcel. Furthermore I basically give no value to UK & Italy and assume Mondial Relay to reach FCF break even in 2027 – the latter perhaps an overly conservative assumption. Also, the discount rate is constant and reflective of the current relatively high yield environment. As Mondial Relay grows, Euro denominated cash flows should grow (as % of total cash flows) which reduces the overall cost of capital.

I believe these are fairly conservative assumptions, but I’m willing to discuss in the comment section.

Catalyst

Continued rising ecommerce penetration

Sustained utilisation levels

Cash flow generation over medium term

Mondial Relay PUDO conversion