Nordic Transport Group - an efficient M&A machine in a boring industry
My quest in small- and micro-cap land continues. The next candidate for a spot in my portfolio was highlighted by a fellow individual investor (thanks, Sergey!). It’s a fast-growing highly acquisitive business that operates in a boring, fragmented, low-margin industry and generates a decent return on capital.
Business overview
Business model
NTG is an asset-light freight forwarder that offers customized transport solutions by road, rail, air and ocean. Freight forwarders act as intermediaries between customers who need to transport goods and owners of transportation assets (ships, planes, and trucks). Put simply, NTG buys transportation capacity and sells it at a margin. Focusing on small and medium enterprises, the company creates value for customers by optimizing their supply chains. Instead of engaging various participants of the logistics chain on their own, customers can use NTG as a one-stop shop: NTG arranges delivery from point A to point B in an optimal way taking care of everything in between. NTG’s services range from generic to specialized like furniture transportation or refrigerated transportation. “Everything from frozen ducks at -25°C to fine chocolates at +15°C”.
NTG operates in two segments: road & logistics (60% of revenue) and air & ocean (40%). The mix has shifted after the company’s largest acquisition to date which took place in 2022 and increased the share of air & ocean segment from 24 to 40%, also making the US the second largest geographic segment.
NTG operates 65 subsidiaries in 22 countries. The company is asset-light: it leases ~2,500 trailers while the trucks are provided by third parties (I had no idea that ownership of trucks and trailers is often separated), and warehouse space is also leased. This gives NTG the flexibility that it may need in a downturn: it can scale down operations quickly without significant losses.
NTG focuses on small and medium businesses. The customer base seems to be well diversified: according to the 2021 annual report, no customer contributed more than 10% of revenue and as per the IPO prospectus (2019), the largest customer accounted for ~5% of revenue.
NTG is a serial acquirer: the company did 29 M&As since 2011. They buy at least a 51% stake in small and medium-sized companies. Employees continue to own the remaining shares but can later be bought out by the parent company in exchange for cash or NTG shares. NTG provides capital, marketing, IT infrastructure, administrative support and other functions so that partners can focus on their core business while also benefiting from economies of scale and shared resources.
NTG states three principles of management: empowerment, decentralization, and collaboration, claiming that “decentralized setup” is a part of their culture. Although the subsidiary is obliged to function within certain operational and legal frameworks, local management has the freedom to make commercial decisions. This reminds me of Berkshire which also gives freedom to its subsidiaries as long as they deliver financial performance. Intuitively these principles should work well in the freight forwarding business where a lot depends on personal relationships with customers and an understanding of local specifics.
M&A is not the only growth engine. NTG is also constantly launching greenfields in new geographies and niches. As of 2022, the startup count stands at 34. The new business is normally tested for 6-9 months and if it does not work they shut it down it. According to a former manager, the success rate has been quite high at 90-95%, while startup costs are relatively modest since expenses consist mostly of office space leases and salaries.
Market
I have come across a wide range of estimates for the global freight forwarding market size: from $200bn to $290bn as of 2021. Apparently, the difference is caused by varying definitions of the market, but one common theme is that the key driver of the freight forwarding market is international trade.
Interestingly, after a huge boost in the 2000s which I guess was mainly driven by the rise of China, global trade lagged behind GDP growth in the last 10 years. I prefer to avoid forecasting macro, but as some degree of de-globalization seems almost inevitable now, I would expect global trade of goods to trail global GDP in the coming years or to grow on par with it at best. Some international trade routes will probably be substituted with the expansion of regional trade routes (e.g. within the EU) or alternative international ones (e.g. less trade with China but more trade between US and EU), but overall I would not expect any major macro tailwinds for NTG.
According to NTG, the growth rate of the global freight forwarding market has a 1.5-3.0x multiple to global GDP growth depending on a specific sub-sector and geography. However, I am less optimistic; I would expect that the market may grow in line with GDP and/or global trade, potentially even lower if the deglobalization trend persists.
The freight forwarding market is relatively fragmented: the largest player (DHL) has a 6% share, top-5 players account for 20% of the market, top-20 account for 40% of the market. I was surprised by the scale of fragmentation: in the US alone there are almost 100,000 freight-forwarding companies. NTG states that the European road transportation market comprises 500,000 companies, but it looks like this number includes not only pure freight forwarders but also owners of transportation assets like trucks. The air and ocean segment is more concentrated as economies of scale play a larger role in it, but according to NTG estimates top-10 players still control less than 50% of the market. No matter how you slice it, there appears to be a lot of room for consolidation. DSV, a top-3 freight forwarder, also highlights the consolidation trend and is trying to capitalize on it.
I have not found more recent data, but as of 2018, NTG was a top-5 player in the Nordic road market while being outside of the top 20 in all other markets. Even factoring in the growth since 2018, NTG remains a relatively small player.
I’m not yet sure whether there is a strong moat in the freight forwarding business, but my hypothesis is that if it exists, it is based on three factors:
Long-standing relationships between customers and freight forwarding managers. If I’m an SMB that has recurring shipping needs, I probably have a relationship with a few freight forwarders that help me manage the whole process. Even though the service itself is a commodity (unless I have some very special needs), I want to sleep well being sure that my freight gets delivered on time and safely. My guess is that personal touch is also important: building and maintaining trust with a particular manager in a small freight forwarder is much easier than with a soulless large company that doesn’t care much about my relatively small orders. Other things equal, I wouldn’t experiment with changing a freight forwarding company or trying to replace it with in-house expertise (unless my business has grown to a scale that makes it feasible).
The power of an international network of autonomous subsidiaries. The more local subsidiaries and subcontractors across geographies a freight forwarder has, the better solutions it can offer to its clients. NTG’s organizational structure with fairly autonomous subsidiaries probably also helps to serve clients efficiently by minimizing bureaucracy.
Economies of scale. According to an industry expert interview (NTG’s ex-employee), economies of scale are very important in the freight forwarding business. They manifest in better rates offered by shipping lines and airlines, cheaper fuel for trucks, higher capacity utilization of leased trucks, etc. Notably, the same expert believes that NTG has already realized all possible economies of scale in terms of costs in the road segment in Europe: higher scale will not result in better prices for diesel, ferries and other inputs.
A separate question worth asking is whether the industry can be disrupted by new technology and specifically tech companies that may try to substitute traditional freight forwarders with a fully automated platform. My uneducated guess is that this threat is low at the moment. While the freight forwarding service is a commodity and many processes probably can be automated, it looks like personal communication and trust still plays an important role for customers. To my mind, a more realistic scenario is heavier use of software by existing market participants (for example, NTG mentions the IT platform as an important factor in increasing efficiency), but not a disruption by some challengers relying only on new tech.
Management and employees
The good thing about NTG’s management is that they all have been operating in the freight forwarding industry for quite a while and a few of them have a track record of establishing, growing and selling businesses to strategic acquirers.
Co-founders
Jørgen Hansen co-founded NTG in 2011. He has been working in the logistics industry since the late 1970s; in 1989 he established a logistics company Combifragt Group which was acquired by Finnish Post in 2005. Since 2018 Jørgen doesn’t have an executive role in NTG but sits on the Board. He holds a 17% stake in the company.
Stefan Pettersson joined NTG in 2013 as a partner and GM of NTG Sweden which has since become one of the fastest-growing subsidiaries within NTG. Stefan has been working in the warehousing and logistics industry since 1989 and founded a forwarding and logistics company PS Logistics that was acquired by Itella Group in 2007. He holds an 11% stake in NTG.
CEO
Michael Larsen has been with NTG since its inception in 2011. He is the founding partner and former CEO of NTG Nordic, one of the largest NTG’s subsidiaries. Michael has 20 years of experience in the freight forwarding industry.
CFO
Christian Jakobsen joined NTG in 2018. Prior to that, he held senior financial positions in the transport industry.
Segment CEOs
Søren Holck Pape, CEO of Air & Ocean segment joined NTG in 2021. He has more than 20 years of experience in the freight forwarding industry, including international experience.
Jesper Petersen, CEO of Road and logistics segment joined NTG in 2016. Jesper has more than 40 years of experience in the freight forwarding industry. He also has successful entrepreneurial experience having built and sold a freight forwarding company in Italy.
Motivation scheme
Management’s incentive plan components and weights:
Short-term: EBIT (35%), revenue (35%), acquisition growth (10%), strategy (10%), ESG (10%).
Long-term: revenue growth (50%), EBIT margin (50%).
I believe that the structure of motivation programs can add some valuable information about the company’s likely course. As Munger puts it, “show me the incentive and I’ll show you the outcome”. I would prefer to exclude BS metrics like ESG (but I assume the pressure to include them is intense), decrease weights of growth components (otherwise we may incentivize empire building), and add capital efficiency metrics like ROIC (which NTG also shows in results presentations). But overall NTG’s motivation program looks reasonable.
Most importantly, the interests of managers and shareholders are aligned through equity ownership: 200 partners own shares in subsidiaries or the parent company. 19% of NTG is owned by managers - I haven’t come across many public companies that have such a high proportion of shares owned by management.
Employee feedback
Publicly available employee feedback is pretty scarce with just 12 Glassdoor reviews, so the statistical significance is questionable. With that caveat in mind, the average review score is pretty low at 2.6 out of 5. A common theme among reviews is insufficient training provided to new employees. But given the number of operating subsidiaries and a very low number of reviews, I would not place too much importance on this.
Ownership structure
Insider ownership is pretty high at 50% which normally signals proper alignment of interest. 28% is split between co-founders, 19% belongs to partners who operate or used to operate NTG’s subsidiaries, another 2.6% belongs to management and board members. Institutions own around 20% which is not particularly low, but still leaves room for more inflows from institutions.
Strategy
NTG’s medium-term financial target is crisp and clear: DKK 1bn EBIT by 2027. The company plans to achieve it under the following assumptions:
Organic and M&A growth financed by cash flow and debt (Net Debt/EBITDA <3.0x; currently at 1.6x)
No equity raises are implied by DKK 1bn EBIT target, but NTG may raise equity for larger M&As
Stable macroeconomic environment (the current environment as of March 2023 is anything but stable in my opinion)
The financial target looks pretty unambitious given that NTG is expected to generate DKK 725mn of EBIT in 2022 (implying just 7% CAGR till 2027) and at least some of M&A synergies haven’t yet been realized. Has NTG been overearning that much in 2021-2022? Is the management just sandbagging forecasts?
NTG is targeting a medium-term EBIT margin of 4-5% vs ~7.5% achieved in 2021-2022. Based on comparable companies and NTG’s results in prior years the 4-5% level looks reasonable.
M&A is likely to remain the core growth driver. NTG lists the following benefits of M&A which all make sense to me:
Having a more global, interconnected, and larger network
Entering new verticals for diversification and getting network synergies
Expand market or trade lane coverage to improve value proposition for customers
Achieve economies of scale
This sounds good in theory, but it is common knowledge that M&As more often destroy value rather than create it. The problem with M&As is usually twofold:
Acquirers overpay.
According to a former manager, NTG pays 4-7x EBIT multiples depending on financial situation and growth, sometimes even cheaper if the target is struggling. As a cross-check, in 2022 NTG paid ~7x EBIT for AGL, its largest acquisition so far. It looks like NTG is overpaying given that their own shares currently trade at ~10x EV/EBIT and reached ~25x at peaks.
Integration costs are higher and synergies are lower than expected.
NTG’s efficiency in terms of integration costs and realization of synergies is harder to assess. Judging by a steady ROCE of ~20%, one may assume that they are pretty efficient.
M&A focus may also help NTG to grow in a value-accretive manner even in a downturn: smaller companies may struggle and may get acquired by NTG at low valuations (the company is cash generative and still has some debt capacity).
The growth runway is likely really long because the industry is still very fragmented and NTG acquires small and medium-sized companies that are just too small for bigger guys to justify their efforts on M&A.
When it comes to capital allocation, NTG’s approach is well laid out too which always appeals to me as a potential investor:
Maintain leverage ratio within the target (Interest bearing Net Debt / EBITDA <3x)
Keep enough cash to invest in M&A and organic growth
Purchase minority stakes in subsidiaries and fund share-based compensation programs
Distribute excess capital to shareholders in the form of buybacks (prioritized over dividends)
Financials
* Organic + M&A growth does not equal total growth due to FX component that the company has been showing separately since Q1 2021
Historically revenue growth has been driven mostly by the road & logistics segment, but the 2022 M&A gave a boost to air & ocean segment too.
NTG obviously enjoyed abnormal operating margins in 2021-2022, I would expect something closer to 4-5% in the mid- to long-term. The relationship between gross margins and operating margins has been unstable. Sometimes they acquired lower margin competitors, sometimes a particular subsidiary didn’t perform well putting pressure on margins, etc. The only consistent trend that I spotted in management commentary is that they are improving operational efficiency in all acquired units which improves overall operating margins.
NTG’s operating cash flow has been growing with EBIT while also benefiting from relatively low working capital: terms of payment are such that receivables are normally only slightly above payables, while the company doesn’t carry any inventory. Maintenance capex is minuscule due to a lack of physical assets, but NTG has been investing heavily in greenfields and M&As. Even accounting for investments in growth, NTG has been steadily generating FCF.
The balance sheet is fairly conservative with Net Debt/EBITDA at 1.6x as of Q3 2022 with 70% of NTG’s debt in the form of lease liabilities. Management states 3.0x interest-bearing Net Debt/EBITDA as the upper limit if the company needs to raise debt to finance further acquisitions. I would probably start feeling uncomfortable if they increased debt to this mark, but it depends on the part of the cycle and consequently cash flows and margins.
Valuation
Share price and P/E evolution chart looks pretty familiar as many pandemic beneficiaries exhibited similar patterns: a run to inadequate highs in 2020-2021 followed by a bust. But is the current price low enough to justify a buy?
Unintentionally my back-of-the-envelope estimate of 2027 EBIT turned out to be close to the management target (DKK 1.1bn vs 1.0bn). I used the following assumptions:
Despite a likely macro slowdown, the company will still continue growing via greenfields and M&As, although slower than previously, resulting in 5-year revenue CAGR of 17%.
2021-2022 EBIT margins have been abnormally high and should return to something in the 4-5% range. We could expect some upside in margins if we look at public comps (DSV and Kuehne+Nagel), but they are 30-40x larger (economies of scale) and the services offered are not exactly the same as NTG’s.
Interest expense and profit tax rates will remain flat for the forecast period. Ideally, interest expense should be adjusted for potentially higher interest rates and extra leverage that may be required to fuel growth, but given a relatively low debt load I ignored this for the sake of simplicity.
As of the time of this writing (March 2023) the company doesn’t look particularly cheap at ~13x P/E 2022E and 23x P/E 2023E (if we assume a steep decline in margins that is highly likely in my opinion). NTG is also not a screaming buy in terms of P/E/G: 1.5x FY 2022E and 2.5x FY 2023E (applying 9% Net Income 5-year CAGR). On the other hand, if they keep generating ~20% ROCE, the market may still value them at 15-20x P/E 5 years from now. In this case, the current price could be justified. I also have a feeling that management is sandbagging medium-term guidance (DKK 1bn EBIT), so there is likely some upside here too.
However, even in a positive long-term scenario, there may be quite a lot of volatility along the way due to the cyclical nature of the industry. I’m still on the fence but if I decide to build a position in NTG, I would probably do it gradually because a severe macro deterioration may offer us better entry points. But as usual, trying to time the market may fail… Since my initial research, the stock has gone up 30%+ and I’m not sure if we can still get a chance to scoop shares at a more conservative multiple or if the market has recognized the quality of the business and will not offer any discounts.
Investment pros and cons
Pros
Decentralized management system (each subsidiary acts independently within a certain framework) with the alignment of interest between management and shareholders. 200 partners own shares of NTG and/or its subsidiaries; together with executive management they own 22% of NTG shares, and another 28% are owned by two co-founders
Co-founders have decades-long track records in the industry and each has built and sold their previous company to larger players
Impressive historical growth rates (5-year CAGR 28% for revenue and 36% for EBIT) and decent ROCE of ~20%
Clear growth strategy and a history of successful execution
Ample room for value-accretive M&A as the industry is fairly fragmented, while economies of scale incentivize further consolidation
An asset-light business model allows cutting costs in case of a severe economic crisis as the main fixed cost is salaries
Cons
A cyclical industry that is likely to suffer a lot if/when the world falls into a full-blown recession
A commodity-type product with low barriers to entry
Current valuation (13x/23x P/E FY 2022E/2023E and 1.5x/2.5x P/E/G 2022E/2023E) leaves little margin of safety if any