TransContainer — Revenue and cost initiatives paying off

TransContainer — Revenue and cost initiatives paying off

TransContainer (TC) has continued to show strong results, with Q218 EBITDA, reported on 29 August, increasing by 13% y-o-y. The company is benefiting from structural growth, especially switching rail cargo to containers, and Russia’s economic recovery. Recent monthly market data bode well for TC’s Q318 results. It has also continued to pursue initiatives that are benefiting the EBITDA margin by increasing the proportion of Integrated Services, profit-making runs and block trains. Our DCF model gives a valuation of RUB5,200/share (unchanged), which offers 12% upside to the current share price.

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TransContainer

Revenue and cost initiatives paying off

Q3 preview

General industrials

25 September 2018

Price

RUB4,640

Market cap

RUB65bn

RUB65.8/US$

Net debt (RUBbn) at end Q218

2.25

Shares in issue

13.9m

Free float

50%

Code

TRCN

Primary exchange

MICEX

Secondary exchange

LSE

Share price performance

%

1m

3m

12m

Abs

2.2

2.5

15.6

Rel (local)

(3.5)

(5.2)

(1.9)

52-week high/low

RUB5295

RUB3900

Business description

TransContainer owns and operates rail freight assets across Russia. Its assets comprise rail flatcars, handling terminals and trucks, through which it provides integrated end-to-end freight forwarding services to its customers.

Next events

Q318 results

November 2018 (TBC)

Analyst

Robert Plant

+44 (0)20 3077 5749

TransContainer is a research client of Edison Investment Research Limited

TransContainer (TC) has continued to show strong results, with Q218 EBITDA, reported on 29 August, increasing by 13% y-o-y. The company is benefiting from structural growth, especially switching rail cargo to containers, and Russia’s economic recovery. Recent monthly market data bode well for TC’s Q318 results. It has also continued to pursue initiatives that are benefiting the EBITDA margin by increasing the proportion of Integrated Services, profit-making runs and block trains. Our DCF model gives a valuation of RUB5,200/share (unchanged), which offers 12% upside to the current share price.

Year end

Revenue (RUBm)

PBT*
(RUBm)

EPS*
(RUB)

DPS
(RUB)

P/E
(x)

Yield
(%)

12/16

21,988

4,302

248

47

18.7

1.0

12/17

27,782

8,195

472

293

9.8

6.3

12/18e

29,031

8,239

460

235

10.1

5.1

12/19e

32,890

9,235

505

253

9.2

5.4

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Structural and economic growth benefits revenue

Structurally, TC’s adjusted revenue growth is mainly supported by containerisation. Currently, only 6.2% of Russia’s potentially containerisable rail cargo is actually transported in containers and, although this is up from 2.2% in 2001, it lags other large countries such as the US (18%) and India (16%). The company is growing the proportion of more value-added Integrated Freight Forwarding and Logistics Services (Integrated Services), away from basic point-to-point transportation. TC is also benefiting from a cyclical upswing in the rail container market as Russia recovers from the 2014/15 downturn. The Russian rail container market grew by 11.9% in Q218 and then by 16.6% in July, which we think is a positive backdrop ahead of TC’s Q318 results, due to be reported in November.

EBITDA margin boosted by mix and efficiency

TC’s EBITDA margin rose from 43.8% in Q217 to 46.7% in Q218. The growing proportion of revenues from Integrated Services benefited the mix as they are higher margin and create more scalability, and thus operational gearing. The company is also improving its operating efficiency, especially through increasing the number of profit-making runs and block trains.

Valuation: DCF gives 12% upside

We have maintained our valuation of TC at RUB5,200/share. Our valuation offers 12% upside to the current share price and is based on a DCF model, using a WACC of 10.4% and a terminal growth rate of 1%. We think TC seems undervalued compared to the peer group of international rail-based companies given it trades on a 2019e P/E of 9.2x, compared to the average of 15.9x, albeit some discount is probably merited due to Russian risk. We have maintained our current forecasts.

Investment summary

Revenue and efficiency initiatives

TC is the leading intermodal container transportation and logistics company in Russia and the Commonwealth of Independent States (CIS). The company has a 43% share of the Russian rail container market. It is benefiting from an increased rate of rail containerisation in Russia, but at 6.2%, potential containerisation rates remain considerably below other countries. TC has transitioned from a point-to-point logistics company to one able to handle customer orders across the whole supply chain, so that Integrated Services now accounts for 82% of adjusted revenues. The company’s EBITDA margin has risen, boosted by the higher profitability of Integrated Services and efficiency savings coming from an increase in profit-making runs and the amount of containers that travel in block trains.

Valuation: Our DCF offers 12% upside to the current share price

We continue to value TC at RUB5,200/share, which is a 12% premium to the current share price of RUB4,640. Our valuation is based on a DCF model, which we believe is appropriate for a cash-generative company like TC. Our DCF uses a WACC of 10.4%, to reflect Russian country risk, and a terminal growth rate of 1%. TC seems undervalued on a 2019e P/E of 9.2x compared to the average of our international peer group of rail-related companies at 15.9x, although some discount is probably merited for Russian risk.

Financials: Strong Q218 results, led by a rise in productivity

Q218 showed 6% adjusted revenue growth and 13% EBITDA growth y-o-y. Adjusted revenue was boosted by containerisation and recovery in the Russian economy. We think TC’s adjusted revenue outlook is strong as the Russian rail container market saw acceleration in volumes in July. Moreover, the World Bank expects Russia’s economy to strengthen further in 2019.

TC’s EBITDA margin rose from 43.8% in Q217 to 46.7% in Q218, due mainly to a 5% reduction in costs as profit-making runs increased. We expect the annual margin to rise from 41.3% in FY17 to 45.2% in FY20, as we see upside from operational gearing, mix and ongoing productivity improvements (note that Q2 is a seasonally stronger quarter).

To support growth, TC is increasing capex, having cut back during the recession. We believe the company has the balance sheet capacity to finance more capex, while supporting a 50% dividend payout, with net debt/EBITDA of only 0.7x in Q218. We model the ratio peaking at 1.9x in FY20 as capex increases.

Sensitivities: Mainly macro related

Russian economic risk: the main earnings sensitivity is to Russian GDP growth, especially as container volume growth is procyclical.

Sanctions: since 2014, Russian entities and individuals have been subject to both individual and sectoral sanctions imposed by the US, the EU and a number of other countries, with the effects including limited access to debt and equity capital markets, and restricted technology transfers.

Trade flows: import, export and transit account for 53% of TC’s volumes and are therefore affected by Russia’s trade volumes, as well as the balance and economic outlook of its neighbours.


Company description

Overview

TC is the leading intermodal container transportation and logistics company in Russia and the CIS. It operates 25,405 flatcars, 67,909 ISO containers, 60 rail-side container terminals, 175 trucks and 312 semi-trailers. The company was established in 2006, having formerly been part of JSC Russian Railways (RZD), the Russian rail network owner, and fully listed, in both Moscow and London, in 2010. In 2014, RZD contributed its 50%+ two-share stake in TC to JSC United Transportation and Logistics Company (UTLC). UTLC is a 100% subsidiary of RZD.

TC’s customer and sector base is well diversified (Exhibit 1). Note that oil and petrochemical is part of the ‘Other’ category.

Exhibit 1: TC’s revenue by customer and sector in H118

Customer

%

Sector

%

UNICO

6.8

Chemicals

15.9

ILIM Group

5.1

Timber

15.7

RZDL

4.2

Metalware

11.7

Rusal

2.7

Pulp & paper

10.0

Voskhod

2.3

Machinery & equipment

8.2

Transport Development Group

2.1

Non-ferrous metals

5.4

Volkswagen

1.9

Food

4.9

VSCT

1.8

Auto and components

4.6

UMMC

1.6

Other*

23.5

PromExpo-Trading

1.6

Other

69.7

Total

100.0

Total

100.0

Source: TC. Note: *Includes ferrous metals, building materials, oil and petrochemicals, textiles, ores and coal.

Strategy

Management’s strategy is based around four areas (Exhibit 2).

Exhibit 2: TC’s strategic goals

Scale & Leadership

Remain the number one market player in Russia and CIS

Leverage the country-wide business network

Leverage economic growth in Asia

Opportunistic M&A policy

Service & Quality

Keep improving service quality

Facilitate containerisation via new products and services

Become a supplier of choice for the customers

Improve digitalisation

Business Efficiency

Optimise asset structure

Enhance asset utilisation

Increase labour productivity

Effective cost control

Social responsibility

Facilitate economic development by improving nationwide availability of high-quality transportation services

Maintain corporate citizenship

Source: TC

Revenue

Cyclical recovery in rail container volume

TC’s adjusted revenue fell during the last Russian recession, when GDP contracted by 2.8%, but has since recovered and reached a new peak (Exhibit 3).

Exhibit 3: TC’s revenue

FY13

FY14

FY15

FY16

FY17

FY18e

FY19e

FY20e

Revenue (RUBm)

25,328

20,538

20,311

21,988

27,782

29,031

32,890

36,458

Change

(19%)

(1%)

8%

26%

4%

13%

11%

Source: TC (historics), Edison Investment Research (forecasts)

The Russian rail container market saw 9.0% CAGR (2001-07) due to a mix of Russian real GDP growth and containerisation.

Exhibit 4: The Russian rail container market (TEUm)

Source: RZD Information Centre (rzu.ru)

The Russian rail container market is cyclical as seen during the 2009 and 2015 recessions, albeit containerisation provides some structural cushioning (Exhibit 5). Historically rail container volume growth has moved within a range of 0.8x to 9.0x GDP changes.

Exhibit 5: The development of the Russian rail container market

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Railway container market growth (%)

6.6

14.9

15.6

(21.7)

20.0

15.6

10.4

5.2

3.8

(8.0)

10.2

19.0

Real GDP growth (%)

8.2

8.5

5.2

(7.8)

4.3

4.3

3.5

1.3

0.7

(2.8)

(0.2)

2.1

Rail containerisation growth (%)

0.4

3.1

11.9

7.9

14.1

11.3

0.7

6.7

9.0

1.2

8.8

16.4

Railway container growth/real GDP growth (x)

0.8

1.8

3.0

2.8

4.7

3.6

3.0

4.0

5.4

2.9

N/A

9.0

Source: RZD Information Centre (rzu.ru), Rosstat

Since 2016, the Russian rail container market has seen y-o-y growth each month (Exhibit 6). Growth accelerated from 11.9% in Q218 to 16.5% in July, which bodes well for TC’s Q318 results.

Exhibit 6: Russian monthly rail container transportation volumes*

Source: RZD Information Centre (rzu.ru). Note: *ISO containers, loaded and empty.

The Russian rail container market should benefit from a strengthening economy, especially given that container growth is procyclical (Exhibit 7). The Russian economy is recovering from the disruption caused by international trade sanctions in connection with the conflict between Russia and Ukraine over Crimea in 2014 and benefiting from a rise in energy prices, although new sanctions, the sell-off in emerging markets and the weakness of the Russian rouble could provide a headwind.

Exhibit 7: Russian real GDP annual growth

2015

2016

2017

2018e

2019e

2020e

Russian real GDP growth %

(2.5)

(0.2)

1.5

1.5

1.8

1.8

Source: The World Bank, June 2018

Containerisation gaining market share

Currently only 6.2% of Russia’s potentially containerisable rail cargo is actually transported in containers and although this figure rose from 2.2% in 2001 it is still much lower than in the US (18%), India (16%) and Europe (14%). There are a number of factors that are boosting containerisation:

Russia’s size should suit switching from road transport to containerisation, especially over long distances.

The growth of international trade with countries where containerisation is at a higher level.

Technological progress, eg handling technologies.

An ongoing switch from boxcars to containers (Exhibit 8).

Exhibit 8: Switch of cargo to container transportation in the Russian rail market

Source: TC

Under RZD’s pricing, containers receive approximate Class II tariffs, which is encouraging the shift of Class III products, especially aluminium and bulk liquids, into containers (Exhibit 9). There are further pricing advantages in the ability to form block trains, which benefit from additional RZD pricing discounts.

Exhibit 9: RZD tariff structure

Class I (lowest price)

Iron ore, coal, coke, cement, wood, gravel

Class II (medium price)

Grains, crude oil and oil products, food and animals, fertilizers

Class III (highest price)

Lubricants, pulp and paper, ferroalloys, non-ferrous materials, metalware and autoparts

Source: TC

Market-leading position

TC is the leader in the rail-based container transportation market, with a 43% share, and as a result enjoys a considerable scale advantage (Exhibit 10). That said, TC has gradually lost market share as the market opens up. It is also the leading independent company in the rail-side container terminal handling market.

Exhibit 10: Industry market shares

Rail-based container transportation

Rail-side container terminal handling*

Company

Market share

Share change
H118 vs H117

Company

Market share

TransContainer

43%

(2.6%)

Shippers' cargo yards

51.0%

Other, including:

34%

0.6%

Railside terminals at seaports

22.6%

Modul

10%

1.2%

TransContainer

17.3%

FESCO

6%

0.3%

JSC Russian Railways

9.1%

UTLC

4%

0.2%

FinTrans

3%

0.3%

Total

100%

Total

100.0%

Source: RZD Information Centre (rzu.ru). Note: *Share change not available.

Growing the proportion of Integrated Services revenues

One of TC’s goals is to increase the proportion of revenues generated by Integrated Services away from the historical origins of point-to-point transportation as it seeks to control more of the logistics of container handling. In the last three years, Integrated Services has risen from 62% to 82% of revenues (Exhibit 11). To facilitate this transition, TC has invested in rail terminal handling and last mile transportation.

Exhibit 11: TC’s share of Integrated Services revenue

Source: TC

We model TC’s revenue by division (Exhibit 12). The company switched to a simpler divisional classification in FY18. The company’s definition excludes third-party charges from revenue as these are passed straight through to customers.

Exhibit 12: TC’s divisional revenue

RUBm

FY16

FY17

FY18e

FY19e

FY20e

Integrated freight forwarding and logistics services

72,245

83,081

94,713

Agency fees

88

94

98

Other

2,709

2,628

2,496

Total (IFRS definition)

51,483

65,567

75,042

85,803

97,307

Third-party charges related to principal activities

(29,495)

(37,785)

(46,011)

(52,913)

(60,849)

Total (company definition)

21,988

27,782

29,031

32,890

36,458

Growth levels

Integrated freight forwarding and logistics services

27%

15%

14%

Agency fees

(468%)

6%

5%

Other

(59%)

(3%)

(5%)

Total (IFRS definition)

27%

14%

14%

13%

Third-party charges related to principal activities

28%

22%

15%

15%

Total (company definition)

26%

4%

13%

11%

Source: TC for historics and Edison Investment research for forecasts

Expanding internationally

In FY17, TC generated 14% of its revenues from customers outside Russia (Exhibit 13).

Exhibit 13: TC’s revenue split geographically by external customer

Country

Proportion

Russia

86%

South Korea

6%

Germany

2%

China

2%

UK

1%

Latvia

1%

Kazakhstan

1%

Finland

1%

Belarus

0%

Other

1%

Total

100%

Country

Russia

South Korea

Germany

China

UK

Latvia

Kazakhstan

Finland

Belarus

Other

Total

Proportion

86%

6%

2%

2%

1%

1%

1%

1%

0%

1%

100%

Source: TC

TC’s international exposure is even higher than the direct revenues suggest, as the non-domestic segments (transit, import and export) comprise 53% of transport volumes (Exhibit 14).

Exhibit 14: TC’s transport volumes split by route

FY14

FY15

FY16

FY17

H117

H118

Transit

8%

6%

5%

7%

6%

8%

Import

15%

16%

16%

18%

18%

18%

Export

25%

22%

23%

24%

25%

27%

Domestic

52%

56%

56%

51%

51%

47%

Total

100%

100%

100%

100%

100%

100%

Source: TC

TC’s market share is slightly higher on domestic routes, suggesting it could aim to gain share on international ones (Exhibit 15). We think international expansion is important for the long term growth of the company given that it is already the market leader in Russia.

Exhibit 15: TC’s market share on routes in H118

Route

Share

Domestic

47%

Export

43%

Import

41%

Transit

32%

All routes

43%

Route

Domestic

Export

Import

Transit

All routes

Share

47%

43%

41%

32%

43%

Source: RZD Information Centre (rzu.ru)

TC has a presence in Russia and in other countries of Europe and Asia (Exhibit 16). Management is keen to grow its international operations, with the company recently strengthening its China base and launching new routes across Mongolia. Management has also set out the ambition to target routes to India and the Gulf states.

Exhibit 16: TC’s geographic presence

Source: TC

Costs

TC’s EBITDA margin declined during the last Russian recession as revenue fell, but has recovered to a new peak (Exhibit 17). Management had previously targeted a 40% margin and this was exceeded in FY17.

Exhibit 17: TC’s EBITDA

RUBm

FY13

FY14

FY15

FY16

FY17

FY18e

FY19e

FY20e

EBITDA

10,074

7,816

6,526

7,099

11,474

12,375

14,527

16,478

Margin

39.8%

38.1%

32.1%

32.3%

41.3%

42.6%

44.2%

45.2%

Source: TC (historics), Edison Investment Research (forecasts)

Cost breakdown

TC’s main costs, excluding third-party costs, are directly from handling freight and transportation (32%), and employee costs (28%) (Exhibit 18). Management has said that costs are fairly evenly split between fixed and variable.

Exhibit 18: TC’s cost breakdown in FY17*

Freight handling and transportation services

32%

Payroll and related charges

28%

Materials, repair and maintenance

15%

Depreciation and amortisation

13%

Taxes other than income tax

3%

Rent

1%

Consulting and information services

1%

Security

1%

Fuel costs

1%

Charity

1%

Licence and software

1%

Communication costs

0%

Other expenses

3%

Total

100%

Freight handling and transportation services

Payroll and related charges

Materials, repair and maintenance

Depreciation and amortisation

Taxes other than income tax

Rent

Consulting and information services

Security

Fuel costs

Charity

Licence and software

Communication costs

Other expenses

Total

32%

28%

15%

13%

3%

1%

1%

1%

1%

1%

1%

0%

3%

100%

Source: TC. Note: *Excludes third-party charges related to principal activities, which are excluded from company-defined revenue.

Generally, TC has been able to grow revenue ahead of costs and shown good cost control management. However, during downturns the cost base leads to some negative operational gearing. For example, TC’s costs declined by 10% during the downturn in FY14, albeit not enough to offset the 19% reduction in revenue (Exhibits 19 and 20). In our forecasts, we assume some cost growth linked to volumes, but that TC can continue to be productive and thus increase the margin.

Exhibit 19: TC’s cost profile (RUBm)*

FY13

FY14

FY15

FY16

FY17

FY18e

FY19e

FY20e

Freight handling and transportation services

4,315

4,979

5,858

5,972

6,549

5,655

6,107

6,473

Payroll and related charges

5,048

4,609

4,507

5,244

5,809

6,229

6,665

7,198

Materials, repair and maintenance

2,985

2,419

2,275

2,605

3,182

3,723

4,244

4,880

Depreciation and amortisation

1,943

2,461

2,470

2,528

2,668

2,912

3,289

3,646

Taxes other than income tax

724

631

521

543

581

570

598

616

Rent

1,869

443

638

311

279

295

318

347

Consulting and information services

243

212

261

157

232

221

225

234

Security

288

206

211

207

192

181

170

158

Fuel costs

211

172

166

170

155

162

172

179

Charity

130

195

89

254

134

140

148

158

Licence and software

131

107

161

156

130

166

174

187

Communication costs

88

68

70

73

69

79

87

94

Other expenses

1,048

668

621

579

673

856

907

953

Total

19,023

17,170

17,848

18,799

20,653

21,187

23,105

25,124

Source: TC (historics), Edison Investment Research (forecasts). Note: *Excludes third-party charges related to principal activities, which are excluded from company-defined revenue.

Exhibit 20: Change (y-o-y) in TC’s cost base*

FY14

FY15

FY16

FY17

FY18e

FY19e

FY20e

Freight handling and transportation services

15%

18%

2%

10%

(14%)

8%

6%

Payroll and related charges

(9%)

(2%)

16%

11%

7%

7%

8%

Materials, repair and maintenance

(19%)

(6%)

15%

22%

17%

14%

15%

Depreciation and amortisation

27%

0%

2%

6%

9%

13%

11%

Taxes other than income tax

(13%)

(17%)

4%

7%

(2%)

5%

3%

Rent

(76%)

44%

(51%)

(10%)

6%

8%

9%

Consulting and information services

(13%)

23%

(40%)

48%

(5%)

2%

4%

Security

(28%)

2%

(2%)

(7%)

(6%)

(6%)

(7%)

Fuel costs

(18%)

(3%)

2%

(9%)

5%

6%

4%

Charity

50%

(54%)

185%

(47%)

4%

6%

7%

Licence and software

(18%)

50%

(3%)

(17%)

28%

5%

7%

Communication costs

(23%)

3%

4%

(5%)

14%

10%

9%

Other expenses

(36%)

(7%)

(7%)

16%

27%

6%

5%

Total

(10%)

4%

5%

10%

3%

9%

9%

Source: TC (historics), Edison Investment Research (forecasts). Note: *Excludes third-party charges related to principal activities, which are excluded from company-defined revenue.

TC’s EBITDA margin has risen sequentially since 2015, in part due to the benefit of operational gearing as revenues recovered. Another tailwind has been the rising proportion of Integrated Services revenues, which we believe are higher margin, although TC does not split out the divisional margins, as they offer a more valued-added service to customers and are more scalable.

The company has planned better, thus increasing the proportion of profit-making runs, for example by balancing import and export routes, which reached a high of 81.1% in H118 (Exhibit 21). When there are empty runs, the costs are allocated to ‘freight handling and transportation services’, which is mainly why these costs reduce proportionally when profit-making runs increase.

Exhibit 21: Share of ‘profit-making runs’ (%)

FY14

FY15

FY16

FY17

H117

H118

77.1

74.7

77.3

80.2

79.3

81.1

Source: TC

TC has also improved efficiency by increasing the proportion of containers transported in block trains, for which it receives a discount from RZD as they take up less capacity on the railway (Exhibit 22).

Exhibit 22: Share of containers transported in block trains (%)

FY14

FY15

FY16

FY17

H117

H118

42.0

42.5

45.4

52.4

50.1

53.8

Source: TC

Financials

P&L

TC’s Q218 results showed a further y-o-y improvement, especially at the EBITDA level (Exhibit 23). Adjusted revenue growth was 6%, less than the 10% in Q118, but EBITDA showed a 13% increase after 14% in Q118.

Exhibit 23: TC’s recent quarterly results

RUBbn

Q117

Q118

Difference

Q217

Q218

Difference

Revenue*

6.02

6.65

10%

7.0

7.4

6%

EBITDA*

2.14

2.43

14%

3.05

3.45

13%

EBITDA margin

35.6%

36.5%

3%

43.8%

46.7%

7%

Source: TC. Note: *Company-defined metrics.

Adjusted Revenue growth was fastest in Integrated Services, which partly came at the expense of the ‘Other’ category as customers switched services (Exhibit 24). We forecast 9% CAGR in revenue supported by forecast GDP growth (2018-20e), led by an 18% CAGR in revenues from Integrated Services. Our 9% CAGR forecast is less than the 26% growth in FY17, albeit that year benefited from Russia’s economic recovery.

Exhibit 24: TC’s divisional revenue growth y-o-y

Revenue composition

Q118

Q218

Proportion of total Q218 revenue

Integrated Freight Forwarding and Logistics Services

76%

44%

82%

Agency fees

28%

10%

10%

Other

(66%)

(50%)

8%

Total

10%

6%

100%

Source: TC

The Q218 margin increase was boosted by a 5% reduction in costs, despite a 6% increase in revenue (Exhibit 25). The main reason for this was that a further rise in the proportion of profit-making runs led to a further reduction in freight handling and transportation services costs, which declined by 19%.

Exhibit 25: TC’s change in costs y-o-y*

Cost item

Q118

Q218

Proportion of Q218 costs

Payroll and related charges

9%

6%

30%

Freight handling and transportation services

(11%)

(19%)

27%

Materials, repair and maintenance

21%

16%

18%

Depreciation and amortisation

9%

8%

15%

Other expenses

117%

(24%)

3%

Taxes other than income tax

108%

(60%)

2%

Consulting and information services

(41%)

52%

1%

Rent

0%

3%

1%

Security

(4%)

(6%)

1%

Fuel costs

5%

3%

1%

Licence and software

111%

6%

1%

Communication costs

6%

19%

0%

Charity

0%

0%

Total

10%

(5%)

100%

Source: TC. Note: *Excludes third-party charges related to principal activities, which are excluded from company-defined revenue.

We forecast a further improvement in the EBITDA margin to 45.2% in FY20 due to the operational gearing from higher revenue, a mix benefit from a higher proportion of revenues coming from Integrated Services and further efficiency improvements.

Cash flow

Capex is TC’s main capital requirement, reflecting its asset-intensive business model. However, the company is able to flex capex through cycles, for example it stopped spending on flatcars during the last recession (Exhibit 26). Management has said that capex will increase over the next three years, mainly on new flatcars, to support an improved trading outlook.

Exhibit 26: TC’s capex spend* (RUBbn)

Capex item

FY14

FY15

FY16

FY17

FY18e*

Other capex

0.7

1.0

0.6

0.3

1.0

Terminals development

0.6

1.0

0.7

0.9

1.5

Investments in containers

0.4

0.9

1.0

1.3

1.9

Investments in flatcars

2.7

-

0.1

4.9

7.9

Total

4.5

2.9

2.4

7.4

12.3

Source: TC. Note: *Company guidance.

TC’s ability to flex its capex is helped by its average flatcar age of 15.3 years, compared to a useful life of 32 years (Exhibit 27).

Exhibit 27: TC’s flatcar fleet average age (years)

Q412

Q413

Q414

Q415

Q416

Q417

Q218

17.0

15.9

15.0

15.3

15.4

14.4

15.3

Source: TC

Balance sheet

TC has maintained a strong balance sheet position. Net debt of RUB2.25bn at end H118 was almost unchanged vs the end-FY17 position and represented just 0.19x net debt/EBITDA (Exhibit 28). We model an increase in net debt due to the rise in capex, which supports a new peak in revenue, but the net debt/EBITDA at peak is still only 1.86x. All of TC’s debt is rouble denominated and fixed rate, with most financed by bonds.

Exhibit 28: TC’s net debt position

FY14

FY15

FY16

FY17

H118

FY18e

FY19e

FY20e

Net debt (RUBbn)

4.87

3.66

3.53

2.24

2.25

8.18

19.99

30.03

Net debt/EBITDA (x)

0.62

0.56

0.50

0.20

0.19

0.69

1.41

1.86

Source: TC (historics), Edison Investment Research (forecasts)

We assume a 50% dividend payout, which is the policy for state-owned companies.

Management

Both chairman Andrey Starkov and chief executive Petr Baskakov have a long history in the Russian railways industry. Mr Starkov is currently deputy CEO of the Russia Railways and Mr Baskakov has been CEO of TC since 2006. We believe management has demonstrated good cost and capital management during the recessions in Russia, as well as pursuing a range of growth and efficiency initiatives.

Sensitivities

Russian economic risk: the main earnings sensitivity is to Russian GDP growth, especially as container volume growth is procyclical.

Sanctions: since 2014, Russian entities and individuals have been subject to both individual and sectoral sanctions imposed by the US, EU and a number of other countries, with the effects including limited access to debt and equity capital markets, and restricted technology transfers.

Trade flows: import, export and transit account for 53% of TC’s volumes and are therefore affected by Russia’s trade volumes and balance, and the economic outlook of its neighbours.

Competition: TC’s share of the rail container market declined from 60% in 2006 to 43% in H118, reflecting market liberalisation and the introduction of competition, and market share could continue to be lost. However, we believe the pace of loss will moderate as its market share has already declined to 43% and there are scale benefits from being the largest company in the market. Sea freight is also a competitor to rail freight for some volumes.

Stock liquidity: UTLC retains its 50%+ two-share ownership stake, so TC has a low free float of 50% -2 shares. Additionally, there are several other large shareholders, so liquidity is restricted.

Valuation

Our DCF value offers 12% upside to the current share price

We use a DCF model to value TC, which believe is especially suitable for cash-generative companies like TC. Our DCF value is unchanged at RUB5,200/share and provides 12% upside to the current share price of RUB4,640 (Exhibit 29). We use a WACC of 10.4%, to reflect Russian country risk, and a terminal growth rate of 1%. During our forecast period (2019-29), we model 8% CAGR in revenues, as TC benefits from a recovering Russian economy and ongoing containerisation, backed by the large increase in capex. We also increase the EBITDA margin from 41.3% in 2017 to 46.1% by 2029, primarily due to operational gearing from higher revenue. The next scheduled event will be the Q318 results in November, which could be a positive catalyst if the current growth trend continues.

Exhibit 29: DCF value

RUBm

Total discounted cash flows (FY19-29)

36,247

Discounted terminal value

44,181

Total EV

80,428

Net debt (FY18e)

8,179

Equity value

72,249

Number of shares (m)

13.9

Value per share (roubles)

5,200

RUBm

Total discounted cash flows (FY19-29)

Discounted terminal value

Total EV

Net debt (FY18e)

Equity value

Number of shares (m)

Value per share (roubles)

36,247

44,181

80,428

8,179

72,249

13.9

5,200

Source: Edison Investment Research

In the table below we set out the sensitivities of our DCF to different levels of WACC and revenue CAGR (Exhibit 30).

Exhibit 30: DCF sensitivity to WACC and revenue CAGR (2019-29e)

WACC (%)

8.4

9.4

10.4

11.4

12.4

6

6,095

5,044

4,230

3,583

3,059

7

6,523

5,401

4,532

3,841

3,281

Revenue CAGR (2019-29e) (%)

8

7,457

6,177

5,200

4,400

3,764

9

7,964

6,598

5,541

4,703

4,026

10

8,501

7,043

5,916

5,023

4,301

Source: Edison Investment Research

TC trades at a discount to international peer group

For the peer group, we have chosen companies who operate in rail freight (Exhibit 31). On a 2019e P/E of 9.2x, TC trades at a 42% discount to the average of 15.9x of this group, which we believe primarily reflects a Russian discount. That said, we note that TC trades at a premium to Globaltrans, another quoted Russian rail freight company, which trades on 7.3x FY19e P/E.

Exhibit 31: TC’s peer group trading multiples*

Company

HQ

Market cap (converted to US$m)

EV/EBITDA (x)

P/E (x)

Dividend yield (%)

2018

2019

2018

2019

2018

2019

European Transport

Globaltrans Investment

Russia

1,834

4.64

4.46

7.54

7.33

12.45

13.20

PKP Cargo

Poland

598

3.52

3.24

10.33

9.02

2.02

4.31

VTG

Germany

1,786

8.66

7.49

24.42

18.75

1.84

2.19

Average

5.61

5.06

14.10

11.70

5.44

6.57

Emerging Market Transport

China Railway Tielong Container Logistics

China

1,674

11.58

9.57

24.03

20.70

1.01

1.02

Daqin Railway Co

China

17,395

5.54

5.49

8.30

8.17

6.41

6.45

Guangshen Railway Co

China

3,581

6.52

5.55

15.30

12.20

3.37

4.29

Average

7.88

6.87

15.88

13.69

3.60

3.92

Developed Market Transport

Aurizon Holdings

Australia

22,957

14.15

12.94

20.21

17.75

0.89

0.99

Canadian National Railway Co

Canada

11,831

10.97

9.98

18.94

16.51

1.16

1.23

Canadian Pacific Railway

Canada

120,671

13.26

12.32

20.99

18.50

1.79

2.07

CSX Corp

US

51,108

12.30

11.56

20.00

18.16

1.61

1.74

Genesee & Wyoming

US

63,455

13.64

12.33

20.55

18.08

1.62

1.82

Kansas City Southern

US

5,448

11.27

10.13

23.48

19.83

0.06

0.12

Norfolk Southern Corp

US

62,951

12.60

11.90

20.26

18.13

1.20

1.22

Union Pacific Corp

US

5,999

8.52

9.02

17.19

19.62

5.50

4.88

Average

12.09

11.27

20.20

18.32

1.73

1.76

Overall average

9.80

9.00

17.97

15.91

2.92

3.25

TransContainer

Russia

980

5.87

5.00

10.10

9.19

5.07

5.44

Source: Bloomberg data. Edison Investment Research for TC. Note: *Calendarised for December. Priced at 25 September 2018.

Exhibit 32: Financial summary

RUBm

2016

2017

2018e

2019e

2020e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

21,988

27,782

29,031

32,890

36,458

EBITDA (company definition)*

7,099

11,474

12,375

14,527

16,478

EBITDA

6,377

10,403

11,678

14,070

16,025

Operating Profit (before amort. and except.)

3,849

7,735

8,774

10,781

12,379

Intangible Amortisation

0

0

0

0

0

Exceptionals

(223)

25

191

0

0

Other

669

704

101

107

113

Operating Profit

4,295

8,464

9,066

10,888

12,493

Net Interest

(216)

(333)

(636)

(1,653)

(2,705)

Profit Before Tax (norm)

4,302

8,195

8,239

9,235

9,788

Profit Before Tax (FRS 3)

4,079

8,172

8,430

9,235

9,788

Tax

(835)

(1,638)

(1,896)

(2,216)

(2,349)

Profit After Tax (norm)

2,798

5,764

6,242

6,911

7,325

Profit After Tax (FRS 3)

3,244

6,534

6,534

7,019

7,439

Average Number of Shares Outstanding (m)

13.8

13.9

13.9

13.9

13.9

EPS - normalised (RUB)

247.5

471.6

459.6

505.1

535.4

EPS - normalised and fully diluted (RUB)

247.5

471.6

459.6

505.1

535.4

EPS - (IFRS) (RUB)

234.7

470.2

470.3

505.1

535.4

Dividend per share (RUB)

46.8

293.0

235.1

252.6

267.7

EBITDA Margin (%) (company definition)

32.3

41.3

42.6

44.2

45.2

Operating Margin (before GW and except.) (%)

17.5

27.8

30.2

32.8

34.0

BALANCE SHEET

Fixed Assets

40,822

45,983

54,692

70,809

85,392

Intangible Assets

290

384

384

384

384

Tangible Assets

37,847

42,196

50,905

67,022

81,605

Investments

2,685

3,403

3,403

3,403

3,403

Current Assets

11,006

9,756

10,019

10,795

11,512

Stocks

209

287

300

340

377

Debtors

1,605

1,323

1,382

1,566

1,736

Cash

5,603

4,171

4,183

4,183

4,183

Other

3,589

3,975

4,154

4,706

5,216

Current Liabilities

(8,372)

(7,493)

(7,698)

(8,332)

(8,918)

Creditors

(5,592)

(6,068)

(6,273)

(6,907)

(7,493)

Short term borrowings

(399)

(457)

(457)

(457)

(457)

Long Term Liabilities

(8,947)

(7,879)

(13,829)

(25,639)

(35,675)

Long term borrowings

(6,357)

(4,987)

(10,937)

(22,747)

(32,783)

Other long term liabilities

(2,590)

(2,892)

(2,892)

(2,892)

(2,892)

Net Assets

34,509

40,367

43,184

47,632

52,311

CASH FLOW

Operating Cash Flow

7,421

10,670

12,215

14,678

16,699

Net Interest

(165)

(440)

(636)

(1,653)

(2,705)

Tax

(781)

(1,483)

(1,896)

(2,216)

(2,349)

Capex

(2,277)

(6,974)

(11,612)

(19,405)

(18,229)

Acquisitions/disposals

28

33

0

0

0

Financing

1,024

92

51

54

57

Dividends

(4,830)

(650)

(4,071)

(3,267)

(3,509)

Net Cash Flow

420

1,248

(5,950)

(11,810)

(10,036)

Opening net debt/(cash)

3,663

3,534

2,241

8,179

19,989

HP finance leases initiated

0

0

0

0

0

Other

(291)

45

12

0

0

Closing net debt/(cash)

3,534

2,241

8,179

19,989

30,025

Source: TC (historics), Edison Investment Research (forecasts) Note: TC’s definition of EBITDA include interest income

Contact details

Revenue by geography

Oruzheyniy Pereulok 19
Moscow, Russian Federation 125047
+7 495 788 17 17
www.trcont.ru

Contact details

Oruzheyniy Pereulok 19
Moscow, Russian Federation 125047
+7 495 788 17 17
www.trcont.ru

Revenue by geography

Management team

Chairman of the Board of Directors: Andrey Starkov

Chief Executive: Petr Baskakov

Andrey was first elected to the company’s board of directors in 2017. He graduated from the Kosygin Moscow Textile Institute in 1992 with a degree in Heat and Power Engineering, and from the Moscow State University of Economics, Statistics and Informatics in 2008 with a Master’s degree in Business Administration (MBA). Andrey has been deputy СEO since 2017.

Petr was first elected to the executive board in 2014. He graduated from the Moscow Institute of Railway Engineers in 1986 with a degree in Management of Railway Transportation Processes and holds a PhD in Technology. He has been CEO since 2006.

Management team

Chairman of the Board of Directors: Andrey Starkov

Andrey was first elected to the company’s board of directors in 2017. He graduated from the Kosygin Moscow Textile Institute in 1992 with a degree in Heat and Power Engineering, and from the Moscow State University of Economics, Statistics and Informatics in 2008 with a Master’s degree in Business Administration (MBA). Andrey has been deputy СEO since 2017.

Chief Executive: Petr Baskakov

Petr was first elected to the executive board in 2014. He graduated from the Moscow Institute of Railway Engineers in 1986 with a degree in Management of Railway Transportation Processes and holds a PhD in Technology. He has been CEO since 2006.

Principal shareholders

(%)

UTLC

50.00

FESCO

25.07

Enisei Capital

24.50

Free float shares

0.43

Companies named in this report

Globaltrans (GLTR LSE), PKP Cargo (PKP WSE), VTG (VTG ASX), China Railway Tielong Container Logistics Co (0390 HKG), Daqin Railway (601006 SHA), Guangshen Railway (GSH NYSE), Canadian Pacific Railway (CP TSE), Kansas City Southern (KSU NYSE), Union Pacific Corp (UNP NYSE), Norfolk Southern Corp (NSC NYSE), Canadian National Railway Co (CNR TSE), Genesee & Wyoming (GWR NYSE), CSX Corp (CSQ NASDAQ), Aurizon Holdings (AJZ ASX)

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Research: Financials

FinTech Group — Banking joint venture with Austrian Post

FinTech Group (FTG) has announced a landmark 50/50 banking joint venture with Austrian Post (VIE: POST, market cap c €2.4bn) where FTG is supplying the technology while Post offers its established infrastructure. The deal creates a new growth arm for FTG that is expected to break even in 2022 and could act as a blueprint for similar deals in other countries. Meanwhile, H1 results were in line with expectations as margins benefited from strong growth in broking volumes. If FTG can meet its objective of generating €35m net income from the joint venture with Post by 2025, it would provide significant upside in the shares for the cost of the 7% dilution in the capital increase that has funded the deal.

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