This article first appeared in The Edge Malaysia Weekly on July 11, 2022 - July 17, 2022

ALTHOUGH skyrocketing freight rates have eroded margins of manufacturers and other businesses over the past two years, they have fuelled record profits at shipping companies and logistics firms.

Freight rates, however, have come down from their peaks this year as port congestion eases and capacity returns to the market. The Drewry World Container Index, which measures the cost of shipping a 40ft-equivalent-unit (FEU) container on eight major routes to/from the US, Europe and Asia, shows that overall container shipping costs have fallen 20% from a year ago, to US$7,051 as at July 7.

Even so, freight rates are still elevated compared with pre-Covid-19 levels. While high inflation and rising interest rates are likely to weigh on consumer demand and depress freight rates further, supply chain experts believe increased demand as a result of China’s emergence from lockdown and eventual border reopening could effect a reversal.

On the local front, Malaysia-based transport operators such as Tasco Bhd, Harbour-Link Group Bhd and FM Global Logistics Holdings Bhd have reported their best ever yearly profit as they benefited from elevated freight rates and a surge in consumer demand. However, their financial performance is not reflected in their share prices as most logistics stocks are down double digits year to date (see table) as investors appear uncertain about the companies’ earnings growth going forward.

Tasco, for one, announced its most profitable year ever for its financial year ended March 31 (FY2022), registering a net profit of RM65.25 million — up 58% from RM41.27 million in FY2021. Revenue rose 56% year on year to RM1.48 billion.

Even so, its share price had fallen 24% year to date to close at 92 sen last Wednesday, giving the company a market capitalisation of RM736 million. According to Bloomberg, the stock is trading at a 12-month forward price-earnings ratio (PER) of 9.48 times.

In a June 29 report, RHB Research analysts Lee Meng Horng and Raja Nur Aqilah Raja Ali called a “buy” on Tasco with a target price (TP) of RM2.03, implying an upside potential of 121% from current levels. They believe Tasco’s valuation remains undemanding at an FY2023 PER of eight times, and expect its positive earnings streak to sustain despite supply chain challenges and cost pressures, thanks in part to multiple growth avenues driven by capacity expansion and new customer wins.

“While [Tasco’s] management guided that volume for its freight segment is still 20% to 30% lower from pre-pandemic levels, the Department of Statistics reported that Malaysia’s trade flows continued its strong upward momentum in May 2022 despite historically being a subdued month, with exports and imports registering double-digit growth of 30.5% and 37.3% y-o-y respectively — suggesting that there is plenty of opportunity for Tasco to ride the wave of rising trade volume. Also, the projected 5.3% to 6.3% gross domestic product (GDP) growth for 2022, driven in part by gross exports that are projected to grow 10.9% y-o-y, point to the likelihood of stable growth in volume throughput,” they say in the report.

Meanwhile, CGS-CIMB  Research analyst Walter Aw has an “add” recommendation on FM Global Logistics, with a TP of 91 sen based on a PER of 12 times CY2023 earnings. This represents an upside potential of 73% from the stock’s closing price of 52.5 sen last Wednesday.

Aw likes FM Global Logistics for its multimodal logistics service offerings, operations in multiple geographies and robust balance sheet. Its net cash stood at RM76 million at end-March.

“We are not overly concerned about the impact of declining freight rates on FM Global Logistics’ margins, given its status as a freight forwarder (service provider), and not asset owner (not a key beneficiary of higher freight rates). Also, we expect the impact of weaker freight charges to be partially offset by: i) higher freight volumes (given lower freight charges); ii) more efforts to cross-sell other services; and iii) higher overseas operation contributions,” he says in a May 26 report.

In the financial year ended June 30, 2021 (FY2021), FM Global Logistics registered a 124% y-o-y increase in net profit to RM27.04 million, making it the most profitable fiscal year in the company’s history. It is poised to enjoy another record-breaking year as its net profit for 9MFY2022 of RM33.02 million has already exceeded the full-year net profit of FY2021.

Nevertheless, FM Global Logistics’ share price has fallen 39% year to date.

Tiong Nam Logistics Holdings Bhd posted a record revenue of RM691 million for its latest financial year ended March 31 (FY2022), up 15% from FY2021, driven by increased contribution from its logistics and warehousing services. The segment contributed 97.8% to FY2022 revenue, but its net profit fell 55% y-o-y to RM5.11 million due to a share of loss in an associate.

“We continued to register higher revenue from new customer acquisitions and increased demand from existing customers, which was supported by recovering business and consumer activity under the National Recovery Plan,” its managing director Ong Yoong Nyock tells The Edge.

He notes that the top three sectors driving the group’s growth are food and beverage, IT and electrical and electronics.

“We are still on the growth path as logistics and warehousing services are essential to all industries. We are also seeing an increase in global brands and domestic companies adopting our specialist total logistics solutions for greater efficiency and enabling them to focus on their core business,” he points out.

“Additionally, Malaysia’s forecast GDP growth of between 5.3% and 6.3% in 2022, alongside recovering economies across Southeast Asia, is a positive indicator of our resilient prospects. Furthermore, we cater to diverse clientele from various sectors and are not exposed to significant concentration risks should any sector be affected.”

As with its peers, investors have been cautious on the sector as Tiong Nam’s share price is down 23% year to date, closing at 61.5 sen last Wednesday, which translates to a market capitalisation of RM316 million.

In a May 31 report, MIDF Research maintained a “buy” call on Tiong Nam with a TP of 75 sen, as it believes the company would be able to overcome any short-term headwinds, underpinned by its diversified multinational clientele. The research house also expects the losses from 49%-owned associate Terminal Perintis Sdn Bhd to moderate as tourism activities pick up in the coming quarters.

Another company that has benefited from higher freight rates is Swift Haulage Bhd, which listed on the Main Market of Bursa Malaysia in December last year. JF Apex Securities analyst Jayden Tan Kean Dick notes that the group’s freight forwarding business accounted for 11% of its total revenue for the first quarter ended March 31 (1QFY2022), but delivered a high pre-tax profit margin of 49%, up 8.6 percentage points y-o-y.

This made the segment the largest contributor to the bottom line and accounted for 38% of Swift Haulage’s total pre-tax profit. The surge in margin was due to the elevated international freight rates, he says in a May 23 note.

Swift Haulage’s net profit for 1QFY2022 grew 34% y-o-y to RM14.31 million, while revenue rose 4.7% y-o-y to RM160.3 million.

Tan expects freight forwarding margins to gradually normalise in 2HFY2022 on the back of increased supply of global fleet size, which has dented international freight rates.

“The global supply chain disruption has deteriorated, exacerbated by external headwinds such as the Ukraine-Russia conflict and zero-Covid strategy of China. The supply chain disruption may affect the production of business and adversely impact the business volume of Swift Haulage. Other downside risks include shortage of drivers and slowing down of the economy as a result of tightening monetary policy,” he adds.

Nevertheless, Tan is maintaining his “buy” recommendation on Swift Haulage, with a lower TP of 93 sen (from RM1.08) and a lower PER of 13 times (from 15 times) owing to the downside risks. The valuation is in line with its industry peers, which are currently trading at a 12-month forward PER of 12 to 15 times, he says.

The revised TP of the stock still renders upside potential of 107% against its closing price of 45 sen last Wednesday, which gave the company a market capitalisation of RM404 million. Swift Haulage’s share price is down 52% year to date.

Whether or not the recent weakness in logistics stocks mirrors the uncertainty in earnings growth, MIDF Research expects to see all the logistics companies under its coverage, including Tasco, Tiong Nam and Swift Haulage, fare better this year as their clients fully resume business activities. Moreover, the players are on track to complete their capacity expansion plans.

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