Saturday, November 21, 2009

Small Cap Value: ABFS

Relative to the railroads, the trucking industry has fallen off of the radar screen. Berkshire's Burlington buy didn't help. To make matters worse, the trucking industry has driven off a cliff with plummeting freight volumes and falling prices. Despite these troubles, there is reason for optimism. And at least one LTL carrier will be a big winner.

According to research by Satish Jindel of SJ Consulting, the largest players in the LTL (less-than-truckload) segment of the trucking market are:

YRC Worldwide - YRCW ($8 billion)
FedEx - FDX
Con-Way - CNW
Arkansas Best - ABFS ($1.5 billion)
Old Dominion - ODFL ($1.3 billion)

The revenue numbers are mine and represent approximate LTL revenue for the last 4 reported quarters.

FedEx and UPS have targeted the LTL market in recent years as a logical extension of their existing services and network. Along with internal initiatives, both companies have done sizable acquisitions to build their freight presence. UPS bought Overnite in 2005 and FedEx bought Watkins in 2006.

Economic weakness and the accompanying drop in volumes have given industry participants plenty to do in recent years. As a result, acquisitions slowed. As the industry stabilizes, consolidation should accelerate.

The consolidation trend is an ongoing theme. It will likely end in an oligopoly with UPS and FedEx completing their horizontal integration and controlling an increasing share of shipping volumes. The US Postal Service will continue to milk its monopoly, raise stamp prices and beg for bailouts to stay relevant while small independent carriers will survive by offering specialized services.

One catalyst that may accelerate this possible future is the demise of YRC Worldwide. The company launched a debt exchange on November 9. Nonetheless, persistent operating losses weigh on a company already paying for its debt-fueled existence. YRC may not live to see 2011. In this respect, continued weakness in shipping volumes may actually help those with financial staying power. If (or when) YRC fails, industry survivors will have an incredible opportunity to poach customers from a dying giant.

Consolidation has already had a dramatic effect. The top 10 participants in LTL trucking (according to SJ Consulting) had 2008 revenues of $23.7 billion, while the next 10 generated just $4.4 billion in sales (less than FedEx Freight alone). Only a handful of these LTL companies are big enough to warrant the attention of UPS and FedEx should they be acquisition-inclined.

Among the candidates are Arkansas Best (ABFS) and Old Dominion Freight Line (ODFL). Both companies will benefit from any economic rebound. They have pricing discipline and are very well run. At current prices, though, one clearly sticks out.

Arkansas Best (ABFS) has 25 million shares outstanding. The current share price ($24.87) translates into a $623 million market value. With $190 million in cash and has essentially no debt, the balance sheet is impressive by any measure. Fully one third of ABF's market value is represented in cash. It's a nice cushion against further weakness and should cause potential acquirers to drool.

By contrast, Old Dominion's market value is $1 billion. Its balance sheet has very little cash and over $300 million in debt. To be fair, ODFL has an advantage: higher margins. With debt payments to make, this is a good thing. In the most recent quarter, ODFL made $10 million on $322 million in sales, while ABFS lost $5 million on $399 million in sales. On a cash flow basis, the difference was far less dramatic. In fact, ABF generated net cash. ODFL did not. In any case, both companies have managed the downturn exceedingly well.

Regardless, the disparity in value makes no sense.

Despite being very close in size, Old Dominion's market value is 65% higher than ABF's. The gulf widens further if one adjusts for Arkansas Best's cash. The balance sheet differences should help offset Old Dominion's margin superiority, but Mr. Market doesn't seem to notice. While ODLF was the subject of a recent Business Week column (Old Dominion, a Trucker for the Long Haul), ABFS is ignored.

At current levels, ABFS should provide greater upside.

There are many things a trucking firm can't control: industry capacity, the state of the overall economy, and disparities in union exposure among the competition. One must look at factors management can effect to judge their performance. For instance, Arkansas Best is an industry leader in quality (loss prevention) and customer service. CFO Judy McReynolds is top-notch, earning her deserved promotion to CEO at year-end. ABF even excels in the often neglected area of investor relations. Under the direction of David Humphrey, ABF has the best IR department around.

The pressures on the trucking industry are serious and only the strong will survive. Ironically, this is of benefit to companies like Arkansas Best. Its balance sheet ensures a bright future as it will live to capitalize on the misery of others. Concurrently, the ambitions of companies like UPS and FedEx should drive further consolidation. Furthermore, stabilizing freight volumes should help pricing.

All roads lead to Arkansas Best.

Disclosure: The author owns Arkansas Best.

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