This Intermodal Shipper is Massively Undervalued

Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The freight recession of 2009 was a difficult period for all companies related to shipping, but the massive sell-off of the companies' stocks presents an interested opportunity for the enterprising investor. Pacer International (NASDAQ: PACR) is an intermodal shipping company that looks particularly cheap following the downturn.

Intermodal shipping isn't the most exciting industry in which you can invest, but it is an important component of the economy. Intermodal marketing companies, or IMCs, offer shippers lower rates than they would have otherwise received because of volume pricing discounts and the importance of intermodal shipping to railroads. In other words, IMCs exist because their buying power makes it cheaper for shippers to go through them rather than bypassing the middleman. In addition, companies often outsource similar functions like logistics to the transportation companies.

Fierce Competition

IMCs build large networks of shippers that create high barriers to entry for newcomers and smaller players. Once a shipper is in the network, they tend to stick with it until there is a reason to leave. Thus, size is a big advantage in the industry. J.B. Hunt (NASDAQ: JBHT) is the largest company in the space, followed by Hub Group (NASDAQ: HUBG) and Pacer International.

<img src="/media/images/user_13490/pacr-revenue_large.png" />

Hunt's size advantage also gives it an advantage in profitability. It sports a much higher EBITDA margin than Pacer and Hub Group.

<img src="/media/images/user_13490/pacr-ebitda-margin_large.png" />

However, Hunt has a much more diverse base of businesses which also contribute to its profitability. This enables it to cross-sell its services to customers, but it also comes with the downside of having to invest in businesses that offer lower returns on invested capital; intermodal transportation provides the highest ROIC in the company. As a result of Hunt's relatively diverse operations, it does not have the same advantage in ROIC as it does in margins. Therefore, Pacer's growth prospects are just as bright as Hunt's in the intermodal segment.

New Management to Shake Things Up

Pacer has undergone a mini-transformation over the last few years as an overhauled senior management team works to improve Pacer's position in the industry. But Pacer does not need to improve too much in order to be an attractive investment. The company already has a terrific asset-light model where it leases most of its equipment and has a large variable component to its cost structure. It also has paid off all debt and does not intend to carry debt on its balance sheet in the near term.

The company already operates with an attractive business model, and past results prove it. Since 2002, the company has averaged a free cash return on tangible invested assets of 14.7%. If you apply this long-term average to the most recent quarter's $230 million in tangible invested assets, you get a 'normalized' free cash flow figure of $34 million. The company routinely earned free cash flow well in excess of this figure earlier in the last decade before management started ignoring deteriorating operating conditions. If the new management team can get the company back to this $34 million figure, then the company is worth $9.61 per share at a 10x free cash flow multiple. That's almost 2.5x the stock's recent price of $3.91.

It seems likely that management will be able to restore past profitability as the operating environment continues to improve. I'm going to sit on the sidelines as I wait for hard evidence of improvement, but investors who get in now could make a killing.


titans8904 has no positions in the stocks mentioned above. The Motley Fool owns shares of Pacer International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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