This Shipping Company Looks Cheap
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Low margin, capital intensive businesses usually turn out to be the worst investments in any given year. However, occasionally these businesses will trade at a price low enough to become interesting as an investment instead of a speculation. This is the case with Arkansas Best Corporation (NASDAQ: ABFS), one of the largest less-than-truckload (LTL) shippers in the United States. The company competes with the likes of FedEx and UPS, which makes most investors close the 10-k before reading further. Arkansas Best has also suffered in a poor operating environment in recent years, which is why this stock is so cheap. However, the market may have overreacted to the company's recent struggles; it could be worth twice its current share price if things go according to plan.
The 2009 freight recession, during which corporate spending on trucking and transportation dropped precipitously, was extremely painful for Arkansas Best. The less-than-truckload segment is a commodity service with low switching cost, meaning that companies in the space compete on price. As a result, the industry is highly cyclical and margins are always under pressure. Arkansas Best posted its first loss of the decade in 2009. However, most companies suffered during the freight recession, including Old Dominion Freight Lines (NASDAQ: ODFL).
Old Dominion owns higher-margin businesses than Arkansas Best also has a lower cost structure. But it was still hit hard in 2009.
However, while Old Dominion and other LTL competitors rebounded in 2010, Arkansas Best suffered from concessions it made in 2009. The company agreed to caps on fuel surcharges, which put it in the red again in 2010. In addition, Arkansas Best's workforce is heavily unionized, and although progress has been made to reduce labor expenses, it is doubtful that the company will ever have a cost structure low enough to compete on price with Old Dominion, much less shipping giants like FedEx and UPS which routinely earn higher margins than even Old Dominion.
It looks like Arkansas Best is a bad company in a terrible industry. The enormous fixed costs makes the cyclicality brutal, and the large capital investments required to expand makes growth slow and expensive.
As a result of these headwinds, the stock is now trading at a five-year low.
Poor Model, But Cheap Stock
The less-than-truckload industry is brutal and most companies in this segment have poor economics. However, it's hard to argue with cheap free cash flow. Since 2002, Arkansas Best has averaged a 1.54% free cash flow margin. If you apply that margin to trailing twelve months sales of $1.992 billion, you get free cash flow of $31 million. At a 10x multiple, the value is $11.94 per share.
However, more interesting is the company's return on invested assets. The company's pre-tax GAAP earnings have averaged 7.12% of tangible invested assets (tangible assets minus cash) since 2002. After applying the 7.12% average margin to $791 million in tangible invested assets, you get an average pre-tax earnings figure of $56 million. At a 7x multiple of this figure, you get a value of $15.40 per share. If you expect higher growth, a 9x multiple gives a value of $19.80 per share -- more than double the recent price of $9.55 per share.
Should You Buy?
So, the stock is cheap, but should you buy? There are some reasons to think so. First, the company is expanding its service to include one-day and two-day regional delivery. This will give it a larger revenue base from which to draw. In addition, the LTL industry is highly fragmented which presents an opportunity for Arkansas Best to grow through acquisitions. Also, most industry observers expect the industry's favorable pricing to continue for some time as it comes out of the recession, giving the company some breathing room to produce additional free cash flow.
It is up to each individual investor to decide what she is comfortable owning. Investors who buy Arkansas Best must be comfortable owning bad businesses. Those comfortable doing so may be rewarded with a quick double, but the risks of owning poor businesses include quickly-deteriorating fundamentals and enormous downside.
titans8904 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend FedEx and United Parcel Service. 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!