Last year, we evaluated Student Transportation Inc (STB) as an investment. We were intrigued by its high yield of 8% however we were displeased by the fact that the company was guzzling gas for acquisitions and increased capital expenditures. We were not foolhardy enough to be recommending an outright short sale of the company because we felt that the 8% dividend yield was supporting the price of the shares and that we felt that dividend hungry investors didn't know, didn't show or didn't care that the company's biggest source of cash inflows was debt and equity issuance. We determined that it would be an underperformer relative to the major indexes such as the S&P 500 and the NASDAQ composite. Based on its performance since it registered on the NASDAQ on September 6th, 2011, we can see that our expectations about STB being a dead-money underperformer back in September have come to pass as STB's recent share price of $6.34 for its NASDAQ shares is slightly lower than the $7 it fetched when it went on the NASDAQ on September 6th, 2011.
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Source: Morningstar Direct
September 25th was the big day for STB as it needed to prove to Saibus Research and Prescience Investment Group that it has changed its ways and was focused on shareholder friendly financial management. Based on its Q4 2012 results, we can see that the company is focused on chasing revenue at the expense of net income, EPS and ROICs. In its Q4 2012 conference call, it hinted at throttling back its mad dash of acquisitions and capital expense spending by focusing on integrating its many acquisitions. Based on the reputation of the company's management as well as incentives, we'll have to see it in order to believe it. So far in FY 2013, we see the company's operating cash flows declining while its capital expenditures are increasing. However, we are a fair and balanced independent research firm and if we see that the company's management is following through on its promises, we'll acknowledge it even though we're going to holding management's feet to the fire in order to get satisfaction.
STB generated 20.55% total year-over-year revenue growth during its most recent quarter and is targeting 15% for the full FY 2013 period. STB's adjusted EBITDA was negative $3.51M and it decreased by $1.13M in Q1 2013 versus Q1 2012's negative EBITDA of $2.38M. STB's Net Loss eased to $7.6M in the quarter versus $11.2M in last year's comparable quarter however this was due to a $6.8M remeasurement gain on its 6.25% Convertible Debentures. EPS increased to negative $.10 in Q1 2013 from negative $.18 in Q1 2012.
BUSINESS SEGMENT REVIEW
STB's Oil and Gas Segment's revenue declined from $1.6M in Q1 2012 to $0.9M in Q1 2013 due to lower production volumes of oil and gas products and lower oil and gas commodity prices. The 13.6% decline in segment revenues was compounded by a 9% increase in operating, general and administrative expenses. While the $100K decrease in depletion expense helped offset the increase in cash operating expenses, it was not enough to forestall a 100% decrease in operating income for the segment in Q1 2013.
STB's School Bus Transportation Segment
Revenue: STB's School Bus Transportation Segment is the core business of the company. The segment saw its revenue increase by $11.2M and reached $60.7M in Q1 2013. This represented a 22.7% increase from Q1 2012 and it was primarily due to a full year's worth of revenue contributions from 7 acquisitions in 2012 as well as 9 new bid contracts. Acquisitions and bid-in contract revenue accounted for $9.7M in incremental revenue, contract rate increases and net increases in service requirements added $1.4M. These revenue growth streams were aided by $0.1M in positive impacts from the translation of Canadian Dollars into US Dollars. On balance, we would strongly prefer to see the company breakout further the incremental revenue from acquisitions and the incremental revenue from new contract bids.
Costs of Operations: Unfortunately for STB's School Bus Transportation Segment, its acquisition strategy has not generated operating leverage as Q1 2013's costs of operations increased by $11.2M (24.5%) versus 2012 levels. This was due to the inclusion of the aforementioned acquisitions as well as new contracts. Driver's wages as a % of revenue decreased by 40bp and that maintenance wages as a % of revenue decreased by 10bp. We were disappointed that on a percentage of revenues basis, operating expenses increased by 30bp due to an additional year of vehicle leasing expenses and fuel costs increased by $200K but remained at the same 9.9% of revenue in Q1 2013 as in Q1 2012.
General and Admin Expenses: General and admin expenses for the segment were $9.9M in Q1 2013, an increase of $1M (11.8%) versus last year. This incremental expense was due to new business for the company and the rest of this admin expense growth was due to acquisitions completed in 2012 and STB's nine new bid-in contracts. At least the company can make the claim that its General and admin expenses as a percentage of revenue decreased by 160bp in Q1 2013 versus prior year levels.
Acquisition, Depreciation and Amortization Expenses: We've were displeased to see that the synergies we saw for the company with regards to its depreciation and amortization expenses in FY 2012 dissipate in Q1 2013. STB seemed to have some operating synergies with its depreciation and amortization expenses as these expenses increased by 16.1% in 2012 versus a 20.6% increase in revenues during that same period. In Q1 2013, STB's depreciation expenses for its transportation operations increased by $1.2M (30%) versus the prior year's levels and reached $5.2M.
Non-Cash Equity Compensation Expenses: We were displeased that Non-Cash equity compensation expense increased by 60% in Q1 2013 ($0.8M) versus Q1 2012 ($0.5M) and we were especially displeased considering that this expense was nearly five times as much as the company's FY 2012 pre-tax income. We don't think that management should be adding back this expense to Adjusted EBITDA because the Class B shares granted to executives are putable and the company has spent $15M since 2007 repurchasing Class B shares from management. In Q1 2013, the company granted 127,541 Class B Series Three shares worth $847K at the time of the July 2 grant to STB's management and 2,500 shares were put back by STB's management pursuant to the terms of the plan. Considering that this non-cash equity compensation represents over 1% of the companies operating expenses even though it is a low-margin generating, highly indebted company, we think that this program is adding insult to injury to shareholders.
CORPORATE FINANCIAL AND ADMINISTRATIVE MANAGEMENT
Capital Expenses: STB spent $10.6M on capital expenses for new-bid contracts (including $0.5M in new oil and gas wells) and $3.9M on vehicle replacement. The company also harvested $0.5M from the disposal of old assets. The company also entered into nearly $30M of new lease agreements in Q1 2013 for replacement CapEx. The term of these leases is for six years, annual lease payments will be $4.3M and the effective interest rates range from 2.8%-4.6%. We're tired of hearing from management about "growth capital expenditures versus maintenance capital expenditures". Despite all this sophistry management has been spouting about their growth story, operating cash flows have stagnated since 2009 even with the benefit of $260M in total acquisition and CapEx spending.
Source: FactSet Marquee
Pre-Tax Income and Interest Expense is a bit of good news, bad news worse news and ugly news. The good news is that its consolidated pre-tax loss in Q1 2013 was nearly $4M narrower than in Q1 2012. The bad news is that this was due to non-cash accounting gains relating to a $6.8M improvement in its unrealized re-measurement gains on its 6.25% Convertible Debentures. The worse news is that the company's oil/gas segment suffered a $700K decline in its operating income due to lower natural gas prices. The ugly news is that the company's operating income of $11.2M over the last 12 months was 37.5% less than the $15.4M in interest expenses.
One way STB's management could provide greater reporting clarity is to separately itemize its revenue growth from acquisitions and new bids. Right now it lumps revenue growth from those two sources together and we can't determine how much is from a genuine source of organic growth like new bids and how much is due to acquisition-related empire building. We were satisfied with STB's Q3 2012 performance and we have raised our estimated fair intrinsic value of STB's common stock twice from the end of March to May. However, based on the performance of the company during the last two quarters, we think that the company is overvalued by 40% unless it becomes more disciplined with its cash flows and financial management.
In conclusion, though we still believe that STB is overvalued relative to our fair value target, the company still offers an 8.8% dividend yield. However, we don't believe that yield is suitable enough relative to the risks associated with the company. If the company's management was willing to pause its acquisition and capital expenditure spree and focus on improving the ROIC, Net Income and Free Cash Flow results of the company, we think it would be a great idea for income oriented investors. However, we believe that STB's management has to prove to us that it is willing to engage in more shareholder friendly management rather than empire-building to boost revenue and management bonuses.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.