It’s an interesting time for the less-than-truckload (LTL) industry as company management has been very bullish on the possibility of the business bottoming out and preparing for a recovery later in 2023 and 2024, but investors remain concerned The economic outlook for 2024 is mixed.Specifically arc best (NASDAQ:ARCB), with shares of the less-than-truckload company up about 35% since then my last updatebut lags behind others, e.g. old dominion (ODFL) and skirt (skirt) – This isn’t a completely unusual situation, as ArcBest has long been viewed as a riskier, higher fixed-cost operator.
Indeed, ArcBest is not the cost leader in the LTL space, and likely won’t be in the foreseeable future. However, the company did make real progress in improving its cost structure.Less efficient operators do tend to While the profit-diluting business ArcBest has taken on recently will certainly hurt short-term earnings once the cycle turns, if management can stick with the business and reprice it, it could become a “force multiplier” for the economic recovery with attractive margins.
Between DCF and multiples-based valuation methodologies, I think ArcBest is undervalued by at least around 10% right now, and probably around 20%-25% if the freight cycle does bottom out.
Choosing quantity over price has had some serious consequences
The past few quarters haven’t been strong for ArcBest, with the company’s operating income line falling well below sell-side expectations. Given management’s choice to prioritize capacity utilization and pursue trading spot freight in a soft market, pricing and margins were impacted more than expected and more than at (non-union) companies like Old Dominion and Saia, which The company retains more of its profit margins. A focus.
Subpar operating ratios are nothing new for ArcBest and still form a significant part of the bearish case for the stock – ArcBest has a long history of high structural costs (among the highest in the publicly traded LTL space) and Taking lower-priced increments to increase freight while maintaining capacity certainly doesn’t help. That said, it’s still a downward trend over the years as management prioritizes structural cost cutting and margin improvement, and unless things turn out to be much worse in the coming quarters than I expect (which, I admit, is certainly possible), then The asset-based LTL business will still improve through profitability compared with the worst days of the previous cycle.
As the business improves, especially on pricing, I expect profitability to improve. Unions appear to agree. The latest five-year contract, finalized this summer, will deliver wages and benefits at a compound annual rate of just over 5% over the next five years (including double-digit increases in the first year of the agreement), but the union agreed to set it higher The profit sharing threshold – if the operating rate is at or above 96%, workers are entitled to 1% of profits; if the operating rate is below 93%, workers are entitled to 3% of profits, but now only 93% or below You get 1% profit, and 3% comes into play at 87%-89% (for investors unfamiliar with trucking, operating ratio is basically the inverse of operating margin, so lower is better).
Will business pick up soon?
Recent reports from the industry indicate that the business remains under continued pressure.Although ArcBest’s tonnage has improved month by month recently, the tonnage in August still fell by 6%, with Saia and XPO (XPO) showed growth (Old Dominion declined more slowly). Shipments continue to grow, but weights decline. On a more positive note, prices did improve in August. As you might imagine from its decision to take on more of the spot trading business, ArcBest’s year-to-date performance looks like it’s doing well in terms of volume, but not in terms of yield (pricing).
Looking at recent data trends and the company’s management’s comments at a recent sell-side meeting, LTL’s management team remains very confident that the worst is over. Peak season demand is expected to be “good” and pricing is quite tight across the industry.Additionally, the crash yellow Helped create some incremental opportunities and helped alleviate driver shortage challenges for some large companies.
At the risk of stating the obvious, the key unknown is what happens next for the U.S. economy. Industrial activity has been slowing for some time, and manufacturing customers are a significant part of ArcBest’s business portfolio (more than half). Many industrial companies are reporting lower orders and there is evidence of customers destocking earnings in Q2 2023. It remains to be seen how far this destocking process goes. For my part, I’m relatively pessimistic about the outlook for industrial demand in 2024, but so far the trends are better than I expected.
The risks to ArcBest are further slowdowns in industrial activity and consumer demand (events such as a potential government shutdown won’t help), further weakness in freight demand and further deterioration in margins on incremental shipments. More directly, the risk is that the light at the end of the tunnel today is an oncoming train, not the end of a downward cycle.
But ultimately, demand and quantity will Improvements and pricing will follow. In turn, this will drive improvement in operating leverage – I don’t think the 80% or so operating ratio ArcBest sees in 2022 is any sort of “new normal” yet, but the expectation is just to call for improvement back to the lows anyway -90%s. Additionally, there’s a potential bull market outcome to consider – the volume of these “transactions” ArcBest handles today becomes long-term customer relationships, and ArcBest gains market share during the next upcycle.
ArcBest isn’t out of the woods yet. The asset-light logistics business is still significantly weak, with average daily revenue declining at a rate of 1-10% to less than 20% recently (mainly depending on pricing/yield). Management has warned that the business may post a loss in the third quarter ($10 million to $15 million, compared with a profit of $6 million in the second quarter of 2023), and weak pricing will remain a concern until the economy improves. challenge.
When it comes to the trucking business, it’s normal for Wall Street to look ahead and try to predict turns in the cycle. To that end, ArcBest, Old Dominion, and Saia all hit recent lows in the fall of 2022 (when revenue was still growing in double digits and operating ratios were very good) and have been running ever since. With these stocks down around 10%-20% from their 52-week highs, I think Wall Street is modeling uncertainty for the industry heading into 2024.
I don’t think I’m expecting heroic growth from ArcBest; I expect long-term revenue growth of about 3% (starting in 2022), followed by double-digit declines in 2023, followed by a healthy recovery in 2024/2025 (I think starting in 2022) Starting in the second half of 2024). Margins are clearly down this year (EBITDA margins will likely be 7% versus 11% in FY22 and 10% the year before), but I think 10%-plus margins are definitely possible in 2025. While I do think improvements in margins and asset utilization will support better free cash flow generation, I only expect average long-term free cash flow margins to improve by about half a percentage point.
Discounting those future cash flows back, I get a fair value estimate of about $120 today. Valuations based on multiples provide me with a broader range of results. Looking at my projected end-2024 operating margins (again, Wall Street tends to look ahead to these stocks), a “fair” forward EV/EBITDA appears to be about 6.25x, which gives me a fair value estimate of about $110 in 24 . However, using a P/E ratio, I get numbers ranging from $110 (using 17x trough ’23 EPS) to $128.50 (using 13.5x next year’s EPS (the long-term average forward P/E)).
I don’t want to give the impression that $110 is the worst-case “floor” for the stock – if the economy weakens significantly, expectations for the remainder of 2023 and 2024 will certainly fall. If you are bearish on the U.S. economy, this stock may not be for you in the short term. However, beyond the near-term weakness and uncertainty, I still see some upside – I think the leverage for further cost improvements (and possibly continued volume improvements) are being undervalued, and I think relative to the upcoming opportunities , the stock trades too cheaply (whenever the business does turn around) to produce better results.