Description

Almost three years to the day Austrian Post was a well received idea on VIC and we believe it offers an even better opportunity today.

Oesterreichische Post AG (POST AV) is the national post office of Austria.  The company was listed on the Vienna exchange in May 2006 with 53% still owned by the government.  It currently trades with a market cap of €1,276MM and intends to pay out at least 85% of earnings in dividends (currently around 7-8% dividend yield).  The extraordinary aspect of this investment is that after putting in an admirable performance during the turmoil of 2008 (total return +12.4%) it has steadily declined during the markets' rally from March.

This type of price action clearly points towards a defensive stock being unwound but also leaves value investors with a terrific opportunity.  At its current price POST is offering investors €4.67/share in surplus assets and an operating business that should generate about €2.15-2.20/share in after tax cash flow to owners.  This means if an investor assumes no future growth they are paying about 6.4x (15.4% yield) for a stable, transparent business that has been a great cash generator.

We believe this is quite cheap for what is essentially a high quality bond growing at a multiple of GDP.  Management has done a good job addressing costs and there are a number of events in the coming months that are expected to improve the company's prospects.

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POST has three distinct divisions:  direct mail, parcel & logistics and the branch network (see table below).  Mail is the main driver representing about 60% of sales with an EBIT margin of 16.1%.  The other two divisions have been a drag on EBIT in the first half of 2009.  The groups EBIT margin is currently 6.50% down from 6.8% in 2008 and off 15% from the highs of 2006.

Overall, management is being quite cautious about the company's prospects for 2009.  They expect sales down 4% on the year, in line with the Austrian GDP forecast.  First half numbers have so far validated their forecast.  According to management, sales were lower in the mail division for the following reasons:

• Electronic substitution, primarily with telecoms and utilities (15%-20% of volume)
• General cuts on postage costs.
• Advertising decreased (5% or €40mm decrease since the start of the recession).

Some of this is expected to return as the economy recovers. Other parts such as the electronic substitution is part of the general attrition that cannot be recovered (POST expects a 2% decrease per year mostly in C2C).  Their main concerns are from the SME's where the crisis has hit particularly hard making it impossible for management to predict how these companies will react in the next 6 months.

On the positive side, POST expects sales to stabilize and has actually seen the large financials increasing their direct mail volumes.

Parcels and logistics have had mixed results in H1 2009.  Volumes are down because of the recession but they won back a customer (and about €20mm a year starting June 2009) originally lost to Hermes (main competitor in this sector).  According to management, Hermes has struggled with the price war and they believe more business will return to POST.  If Hermes were to leave the market entirely (not out of the question) POST would see a 1%/year increase in parcel volumes. 

Also noteworthy is some of the large parcel companies (DHL, FedEx and UPS) have started outsourcing deliveries to small Eastern Europe countries where POST has operations and compatible software to interact with the majors.  It's still early to calculate what this could mean to sales.

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Costs

POST's largest handicap is the fixed cost base in the mail division.  Currently 85% of all costs are fixed leaving 15% variable.  In a serious downturn, like 2008, an inability to adjust costs eats into profit quickly.  POST, however, is making progress lowering this ratio.  So far this year they expect to cut staff costs by €36mm with full year savings to be around €45mm.

Additionally they entered into a new collective bargaining agreement which is likely to cut the overall cost base for employees by 25% over the next 2 years.

POST is also trying to resolve the job-for-life schemes that were imposed in earlier years.  The "jobs bank" has been a bulky unproductive cost for the company but there is a good chance it could be significantly reduced or eliminated by 2010.  Recent government action has promised to move people in the "jobs bank" to other short staffed areas of the civil service (mainly government and police administration).  This is a huge win for POST and could eliminate all 500 people currently in the "jobs bank".  Management is taking a conservative view, expecting only 100-200 in 2010.  At €42k a head that could be an additional €4-8mm a year in savings (if all 500 go, its saves the company €21mm/year).

A second area that could see permanent cost savings is the postal outlets.  Although the program to change into owner operated has been delayed (see more below) POST expects to have transitioned 100 outlets by August with more coming in 2010.  Each changeover saves about €35-40k with a total of 1650 branches outstanding.  Again, it's early to do the math on this but the scenario is positive.

POST has done a good job in other areas of the cost structure; cutting CAPEX by 20% from 2008 and reduced general operating expenses by €30mm.  Together this should give the company good leverage going forward.

Revenues

Aside from picking up some outsourced contracts from the major parcel companies, POST still has quite a few revenue levers to pull.  The largest being an increase in stamp prices.  It's been over 6 years since Austria raised prices; management is aware of this but waiting until after the postal laws pass before raising the issue (by end October).  We expect a price increase in early 2010, taking effect in 2011.  Raising prices by approximately 8% (suggested) would add nearly €60mm/year to revenue.

Waiting on the postal laws is essential not just for this price rise but also for the tariff governance.  As it stands now all of POST's €650mm generated from direct mail is regulated.  If the current postal law goes as expected, only €250mm will be regulated with €400mm set by market prices; clearly an advantage worth waiting for.

The small add-on businesses POST acquired over the years will incrementally help the parcels business but we don't expect them to make any major acquisitions to boost the top line.

Another source of future revenue for the company is their print shops.  They currently have a JV with a large bank doing about €50mm/year in revenue and they are focusing on more of this type of business (essentially offsetting the substitution loss caused by electronic mail).  The model has POST receiving the information digitally, compiling, printing and then sending.  Their current infrastructure is particularly well suited and they are seeing traction.

Web based solutions represents a third possibility but this is still in the early stages.  Lastly, POST is also a joint owner in PSK Bank but they do not expect to grow this area.

Postal Laws

For the past three years speculation on the shape and scope of postal liberalization has hung over POST and at times held back its valuation.  By the end of October the new mail laws should be finalized to take effect in 2011.  For POST's future the main issue is the new definition of universal service.  The draft legislation adopted on July 28^th shows both political parties have tentatively agreed on a format favoring POST. 

As it stands today, the new definition of universal service includes a flexible tariff between the country and city and no direct access to the sorting center.  This is a key measure that essentially prohibits outsiders from competing with POST on direct mail.  If a competitor were to build their own sorting center to compete with direct mail, POST could price them out of business very quickly with the flexible tariff regime (i.e. lower city and raise rural tariffs).  To compete on parcels alone would require €60-70mm in revenue to breakeven, not including any initial start-up costs. 

On the downside, the new laws are likely to slow down the changeover for postal outlets but not stop the process.  As mentioned above POST expects to re-start the program early in 2010. 

There has been some speculation on the amount of "fairness" costs the new postal laws will impose on POST.  The main expense centers on the replacement of "cluster boxes" that can only be accessed by POST carriers.  If the company does get levied with the fix, it's likely to cost €40mm but could be done over a number of years finishing 2013.

The bottom line with the new postal laws is the government has no interest granting foreign competition free access to the national mail and has found a way to secure this while complying with the EU directive.

Management

POST has recently appointed George Poelzl as CEO, replacing Anton Wais who resigned for health reasons.  Poelzl starts on October 1^st and brings with him significant experience in marketing and restructuring from his T-Mobile days.  Our research suggests that he is generally well respected and works well with the politicians.  The rest of a very competent management team remains intact.

More interesting is management's longer term performance incentives have not yet been set.  We suspect the new CEO and rest of management are currently playing down their prospects before formalizing the new share based compensation scheme.

Conclusion

Austrian Post is essentially a monopoly with a very solid balance sheet and good cash flow generation trading at approximately 6.4x after tax cash to shareholders.  The stock has suffered lately due to its defensive categorization, analyst's general misunderstanding of the company and impacts of new postal laws.  Our research suggests the risks are overblown and the new laws will work in POST's favor; after all the government does own 53%.  Furthermore, POST has been quietly re-structuring their cost base to be more competitive and has plenty of levers to pull on the revenue side.  Together we believe this will enable them to grow at a multiple of GDP going forward.  Even before considering any growth POST represents a very compelling investment at current valuation.

The new CEO is likely to bring a fresh approach to the company and management should receive new performance incentives by year end.

Top shareholders:  Austrian government 53%, Capital research 5.3%, Greenlight Capital 4.3%.

http://www.post.at/en/

Catalyst

Risks/Catalysts

• Postal laws in October.
• Austrian economy.