This is now my 3rd write-up of YRC Worldwide. See my other two write-ups here:
Sept 11, 2012: YRC Worldwide: A Turnaround Story with Momentum
Nov 12, 2012: YRC Worldwide Turnaround Gains Momentum
YRC Worldwide (YRCW) recently reported Q4 earnings that were a pretty big surprise to me. Coming into the results I expected a rough quarter and quite frankly I exited my position to wait for the results. Typically Q4 is a weak quarter and throwing in Superstorm Sandy, which wreaked havoc on the entire Northeast (truck tonnage was down 3.8% in October as a result of Sandy), I expected results to be far worse than Q3 2012.
In the months since Sandy hit, however, truck tonnage has come roaring back with its best January tonnage report in five years and there are signs that 2013 could be a solid year for trucking. The iShares Dow Jones Transportation Average (IYT) is confirming this, having broken out to new all time highs. While we may go through pullbacks from time to time I expect the trend to continue as the improved housing market continues to generate significant demand for goods and services.
YRCW managed to post an operating profit of $21.1 million in Q4, only slightly worse than the $25 million posted in the seasonally strong Q3 (both of which I have adjusted for one time items). YRCW owns 3 regional trucking businesses that they consolidate as their regional division and a national less than truckload or LTL division known as YRC Freight. YRC Freight was the main driver for these numbers, generating a $18.3 million increase in operating income over the prior quarter and a $48 million increase year on year. After reading through the results, I began repurchasing my shares in the mid $6 area.
After adjusting for one-time effects, mainly an investment impairment of $30 million or roughly $4 per share, the company posted a net loss of $0.58. On a $6 stock that sure as heck looks like a huge loss. Yet, again, keep in mind that this is typically a seasonally weak quarter and also consider the fact that the restructuring in YRC Freight is just in its infancy. Trends in operating income for the entire company are very promising. Look at the recent trend in operating income:
2009: ($882.0) million
2010: ($227.8) million (+654.2 million)
2011: ($138.2) million (+89.6 million)
2012: $24.1 million (+$162.3 million)
Now look at the trends over the past 8 quarters:
Q4 2010: ($27) million
Q1 2011: ($68) million
Q2 2011: ($5.6) million
Q3 2011: ($36.9) million**
Q4 2011: ($25.2) million** (+1.8 million)
Q1 2012: ($40.4) million** (+27.6 million)
Q2 2012: +$9 million** (+14.6 million)
Q3 2012: +$25 million** (+61.9 million)
Q4 2012: +$21.1 million** (+46.3 million)
**Adjusted for one time items
While I again expect little in the way of positive earnings in Q1 2013, I think Q2 could surprise people. In 2011 and 2012 the average increase in operating income from Q4 of the prior year to Q2 was +$28 million. If you use very rudimentary math and apply the same increase to 2013 you arrive at an operating income of almost $50 million. After backing out interest expenses of $38 million per quarter it's possible YRCW could post positive net earnings of $12 million by Q2 2013 (or about $1.55 per share).
YRCW has a share count of roughly 7.8 million shares. There are two convertible notes: (1) the series B notes are convertible at $14 (roughly 7 million shares), and (2) the series A notes are convertible at $34 (roughly 6 million shares). Let's consider that the series A notes won't be converted any time soon (if they do then that would make this a 5 bagger…which by the way I actually believe could happen over the coming couple of years if recent trends in performance continue). With the series B notes fully converted the company would have roughly 15 million shares.
While the operating performance in Q4 was certainly respectable in light of the fact that it is a seasonally slow quarter and they had to contend with Hurricane Sandy, the market only offered a one-hour or so pop before the shares fizzled out and are now trading around where they were before the report. So what will it take for the market to recognize this turnaround story? That I can't answer, but I believe the odds of the market waking up to the turnaround at YRCW are increasing by the day.
Again, Q1 is a slow quarter and it will most likely show an operating loss or right around breakeven. With interest expenses, the bottom line will again look weak. However, come Q2 and Q3, the numbers will look significantly better. And if recent trends in operating ratios (i.e., expenses dividend by revenues) continue at the Freight division, where the ratio has dropped from 107.1% to 97.3% in the past 3 quarters, you could very well see YRCW posting net income even during the seasonally weak quarters by the end of 2013.
I have witnessed firsthand the turnaround stories of Sirius (SIRI), Pier One (PIR), Foster Wheeler (FWLT), and MEMC Electronics (WFR), amongst others, and each one of them were sluggish near their bottoms for a while. Yet as soon as the market woke up to their turnaround stories they ran so hard for so long that it made your head spin.
A great example in terms of similar fundamentals is FWLT. In 2004 FWLT was a trainwreck. It had massive potential asbestos liabilities outstanding and a huge negative equity position. It underwent a massive $400 million debt for equity swap and the stock cratered (sound familiar?). Yet the stock bottomed out that year at $4 and went up 20 fold over the next 2 years, returning to the same market capitalization it was at prior to the downturn.
In looking at its valuation really there are only two metrics to go by: Enterprise Value (EV) / EBITDA and price to sales. I will focus on the latter right now. Below is a chart of 8 companies, including YRCW, in the transportation industry and their estimated 2013 revenues and current market caps.
Based on a ratio of their market cap to revenues (i.e., price to sales), the average ratio excluding YRCW is 0.70 (includes Old Dominion Freight Lines (ODFL), Saia (SAIA), Swift Transporation (SWFT), Werner (WERN), JB Hunt (JBHT), Conway (CNW) and Arkansas Best (ABFS). YRCW currently trades at a 0.01 price to sales. The other major unionized trucking company, Arkansas Best, sports a valuation 13 times higher than YRCW, relative to its sales. This shows you just how little consideration the market has given YRCW in turning around its business. My guess is investors simply don't care, being too focused on the recent history and unable to consider possible positive developments in the future. The majority of investors are so focused on short-term profits that they miss out on monster turnaround stories.
Look at the potential leverage in this business. If the company were to grow revenues 1% it would generate $50 million in additional revenues. Operating at a 68% gross margin, that could yield $34 million in additional gross profit, or $4.35 per share based on current share count of 7.8 million. Also, consider the possibility that by the time the next major debt payment comes due in 2015, YRCW is generating positive net income. If this happens they should have no problem refinancing their debt at much lower rates, which could significantly reduce their annual interest expense and create considerable leverage on the bottom line.
Before the credit crisis, YRCW was sporting a $3.6 billion market cap and trading at over 0.30 times sales. Even with a fully diluted share count of 21 million shares and an assumption that it gets back to 1/3 of its old valuation or $1.2 billion, you could make an argument that the company could be a 10 bagger over the next couple of years.
Keep in mind as always that there are risks for every stock. The company continues to operate under huge debt burdens with very high interest rates, it has large pension obligations, and it has a unionized labor force. However, YRC is quickly approaching breakeven and it doesn't have any significant debt due until March 2015. There is a $69 million debt maturity in February 2014 but based on recent operating performance, cash on hand, and a positive outlook issued by S&P on YRCW's debt, the potential for this to be either paid off or refinanced is high. On top of that it has an agreement in place with its union until 2015. So the question investors should ask themselves is this: is the market pricing in the risks appropriately? My belief is that it is pretty severely underestimating the turnaround at YRCW.