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Date : 31/08/2023

Kelsian Group

ASX :

KLS

Market Cap : $1.78 Billion

Dividend Per Share : $0.17

Dividend Yield : 2.62 %

Buy

52 Week Range : $4.262 - $7.510

Share Price : $5.38

KLS reported solid performance in a year of high inflation and it's poised for more earnings growth. We retain a 'Buy'

Company Analysis

Kelsian’s (ASX: KLS) FY23 results showed an improved underlying business performance in a year of high inflation rates. The revenue for the year saw a 9.3% increase on the prior year, while the operating expenses increased by 10%, leading to a slight decline in the Underlying EBITDA margin from 12% in FY22 to 11.4% in FY23. This resilience was owed to the essential and non-discretionary nature of Kelsian’s operations, while 92% of the company’s annualized revenue is contracted with governments and blue-chip companies with indexation mechanisms that effectively hedge inflation for the majority of bus business.

Kelsian is one of our top 10 stocks for 2023 and was picked for its defensive nature for a year that was widely expected to be challenging for most businesses. Our previous report on the stock can be found here.

Operating margins can be expected to remain solid for the foreseeable future

Kelsian’s bus businesses’ contract indexation mechanism is designed to effectively hedge the bus businesses’ operating margins by linking fuel prices and wage costs to the CPI (Consumer Price Index). We’ve seen that this mechanism has been effective in maintaining the profitability of Kelsian’s bus operations in the years before FY23 as well. As such, we expect this mechanism to continue protecting the underlying operating margins for Kelsian’s main businesses, which are Australian and International bus businesses with 81% of the company’s total revenue.

Kelsian’s other business division, SeaLink Marine & Tourism business, has also shown itself to be in a strong competitive position with a solid pricing power. The business provides passenger and transport ferries as well as tourism experiences and accommodation, serving 19 unique island destinations. As such, the business is hard to replicate, while its transport services to island residents are essential. Therefore the business’s operations include a range of government-contracted services with a remaining Average Contract Term of 13.3 years as of 30 June 2023. Owing to the lack of serious competition while providing essential and in-demand services, Kelsian’s Marine and Tourism business was able to offset the inflationary costs in FY23 via fare increases. We think its continuing strong pricing power will be able to protect the business’s margins for the foreseeable future.

Kelsian’s revenue composition, source: company FY23 results presentation

Growing through organic growth and strategic acquisitions

In FY23, Kelsian signed new contracts in NSW and increased with a total new contract value of c. $1.3bn over 7 years. The company is set to become Sydney’s largest metropolitan bus operator and already has the largest zero-emissions bus fleet and electrified bus depot in Australia.

However, bus operations are capital-intensive, and this leaves limited avenues for organic growth. As such, Kelsian is very active in the acquisition front to pursue growth opportunities in different geographies and end markets by leveraging its core competencies in managing bus operations. In may 2023, Kelsian entered the large USA market through the acquisition of All Aboard America! Holdings Inc. (AAAHI). AAAHI is an established and highly regarded bus operator with a multi-state footprint across the US, providing KLS with a base to pursue further growth opportunities in adjacent geographies and end-markets in the attractive US market.

In the Marine and Tourism division, KLS purchased four new vessels and was awarded two new 10-year contracts in Gladstone. The company has reported a strong rebound in domestic demand for the business in FY23.

AAAHI’s footprint across the US, source: company FY23 results presentation

Strong earnings growth expectations have been priced into Kelsian’s current market value

Due to Kelsian’s frequent acquisitions every year and the large transaction costs the company incurs for these acquisitions, the company likes to use Underlying NPATA to report on its financial performance. Underlying NPATA excludes one-off costs associated with the acquisitions made during the year and impairment costs as well as amortization.

Kelsian’s Underlying NPATA increased by 4.3% in FY23 to $70m. Based on the company’s policy of dividend payout range of 50-70% of NPATA, the management declared a final dividend of 9.5 cents per share, bringing the full year dividend to 17 cents per share, fully franked. At the closing price of $6.50 on the day the results were released, the dividend equates to a yield of 2.6%. With full franking credits, the grossed-up yield is 3.7%.

The final dividend of 9.5 cents will go ex-dividend on 14 September, with a payment date of 20 October 2023.

The FY23 Underlying NPATA of $70m included only one month contribution from AAAHI. Based on the company’s FY23 results presentation, AAAHI had a total revenue of US$236m in the entire year. Assuming the same margins and tax rate in Kelsian’s FY23 results, and using an AUD/USD exchange rate of 0.67, we estimate the full year contribution of AAAHI in Kelsian’s FY24 Underlying NPATA in the vicinity of $17m, or $15.5m higher than its contribution to Kelsian’s FY23 Underlying NPATA. As such, we estimate the company’s FY24 underlying NPATA to be about $88m, after assuming a yearly 4% growth rate as well.

AAAHI revenue composition, source: company FY23 results presentation

Recommendation

Based on our estimate, KLS is currently trading at an FY24 P/E multiple of 21x, versus FY23 P/E multiple of 25.4x (using Underlying NPATA as a measure of earnings as we agree with KLS that this metric better reflects the normalized earnings power of the company, and also the fact that this is the metric the company uses to determine its dividend payouts).

Given the stable and infrastructure-like nature of Kelsian’s businesses, we think the forward P/E multiple of 21x for the stock is very well justified. Kelsian’s current valuation even becomes more justified after considering the growth prospects of the company as well. That being said, we are cautious about the fact that growth through acquisitions can’t continue forever. There’s always a point after which the efficiency of operations starts to decline with the addition of more business units and expansions to new jurisdictions are not without risk, as was the case for Kelsian’s adventure into the UK market.

While we’re playing this one for its defensive and low-risk nature, in addition to its fully franked dividends, we think investors should be cautious about how much they’re paying for the stock. Therefore, KLS remains on our top 10 for 2023 list as a “BUY” for prices up to $6.75 (the green line on the chart).

KLS in weekly timeframe, source: Metastock

 

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