Ryder System - Steady Growth Ahead

| About: Ryder System, (R)

Summary

Despite turbulent market conditions, stable margins are indicative of Ryder System's ability to incorporate the effect of volatile costs into its service/product prices, thus displaying its robust pricing power.

Moreover, the company is also expected to benefit from several large deals anticipated to be closed by 2016 end.

Based on its fundamentals, the stock is currently undervalued by 71% and is a good buy for long-term investors.

Ryder Ryder System, Inc. (NYSE:R) is engaged in offering commercial fleet management and supply chain solutions. Ryder operates in two segments: Fleet Management Solutions (FMS) and Supply Chain Solutions (SCS). FMS provides service leasing, commercial rental, contract maintenance, and contract-related maintenance of trucks, tractors and trailers to customers in the US, UK and Canada. SCS provides supply chain solutions, including distribution and transportation services in North America and Asia.

Comparable earnings per share from continuing operations were a record $1.74 for the third-quarter 2015, up from $1.63 in the prior year. This is an improvement of $0.11 or 7%. Comparable earnings per share exclude non-operating pension costs of $0.05 in the third quarter of this year and $0.03 last year. The results were below management's initial forecast range of $1.82 to $1.87 but were in line with the top end of its revised forecast range announced in mid-October 2015, where the forecast for the third quarter was revised to reflect a $0.06 impact from a temporary maintenance execution issue and a $0.05 impact from less robust supply/demand conditions in used vehicle sales.

Operating revenue, which excludes fuel and subcontracted transportation revenue, grew by 6% to a record $1.4 billion for the third quarter and was higher in all business segments. Excluding the impact of foreign exchange, operating revenue grew by 8% for the quarter. Total revenue declined primarily due to lower fuel costs passed through to customers. The company also experienced a higher-than-planned number of out-of-service vehicles in 3Q. This occurred because maintenance technicians were supporting new levels of fleet growth across all product lines while at the same time they were continuing to drive further productivity within the maintenance organization. The company has made significant progress on this issue and expected it to be fully resolved in October with no ongoing impact into 2016. In used vehicle sales, there were lower volumes and reduced pricing, particularly in September.

Share repurchase activity remains paused because the company's leverage is now just above the high end of management's target. Management is likely to continue to evaluate the appropriate timing to resume anti-dilutive share repurchases going forward, which would unlock more value for shareholders. On a year-to-date basis, operating revenue was up 6% to $4.1 billion, whereas comparable EPS from continuing operations were $4.47, up 12% from last year.

As we look into 2016, the strong lease sales, particularly those in the back half of 2015, are likely to provide solid year-over-year growth in revenue and earnings. In the rental business, Ryder's management expects strong demand similar to that observed in 2015, which is being supported by growth in its lease and national rental customer base.

Financial Valuation

Here is an excerpt of the company's past performance. Every metric is presented in millions of dollars, except for percentages and ratios.

Ryder (USD Mil.)

CY10

CY11

CY12

CY13

CY14

Sales

5,136

6,051

6,257

6,419

6,639

Sales Growth

5%

18%

3.4%

2.6%

3.4%

Operating Profit

288

350

355

410

348

Operating Profit Growth

4%

22%

1%

16%

-15%

Operating Margin

5.6%

5.8%

5.7%

6.4%

5.2%

Net Margin

2.3%

2.8%

3.4%

3.7%

3.3%

PAT Growth

91%

44%

24%

13%

-8%

ROE

9%

13%

14%

15%

12%

Total Assets/Total Equity

4.7

5.8

5.7

4.8

5.4

CFO/Net Income

8.6

6.1

5.4

5.1

6.3

Click to enlarge

Source: Reuters

As shown in the table above, sales growth has remained steady, averaging 3.6% in the previous five years excluding CY11. Operating profit margins have also remained fairly stable around the 5.7% mark, which is indicative of the company's ability to incorporate the effect of rising and/or volatile costs into its service/product prices, thus displaying its robust pricing power. A similar trend has been witnessed in the company's net profit margins, which have shown a step-like growth - 2.6% in CY10-11, then jumped up to a new handle of 3.5% in CY12-14. The company's ROE has also improved over the past five years, rising from 9% in CY10 to 12% in CY14, albeit with some volatility on the way.

For the fourth quarter, management expects a further modest decline in pricing as compared to what it realized in September. Overall, for the fourth quarter, management expects year-over-year gains on used vehicle sales to be down by the same magnitude as the third quarter with improved volumes offsetting lower pricing. In supply chain, Ryder is likely to witness modest fourth-quarter revenue growth due to lower volumes while strong earnings performance trends are expected to continue. In the dedicated segment, strong earnings growth in the fourth quarter driven by new sales and lower self-insurance expense is on the cards. Our fourth-quarter comparable EPS forecast is $1.72 to $1.82 versus the prior year's $1.59 or an increase of 8% to 14%.

Heading into next year, Ryder is likely to see lower gains on sale due to pricing. However, it should see a benefit in depreciation due to higher residual values using our five-year rolling average methodology. Revenue growth is expected to remain in the high-single-digit level and benefit from several large deals anticipated to be closed by year-end. While management expects rental and used vehicle results to be as described above, the low end of its forecast range contemplates the potential for a modestly weaker environment in these areas. Our full-year EPS forecast is $6.17 to $6.29, an 11% to 13% increase from our prior year's $5.58.

The table below summarizes the projections until 2019:

Ryder - Forecast Assumptions

CY15F

CY16F

CY17F

CY18F

CY19F

Sales

6,820

7,025

7,243

7,467

7,699

Sales Growth

2.7%

3.0%

3.1%

3.1%

3.1%

Operating Profit

341

365

398

426

439

Operating Profit Growth

-2%

7%

9%

7%

3%

Operating Margin

5.0%

5.2%

5.5%

5.7%

5.7%

Net Margin

4.9%

5.1%

5.4%

5.6%

5.6%

PAT Growth

52%

7%

9%

7%

3%

ROE

17%

16%

16%

15%

14%

CFO/Net Income

6.3

6.0

5.7

5.7

5.7

Click to enlarge

We have valued this stock based on comparable Price-Earnings ratio, given that the company's free cash flows have been negative historically and are likely to remain so, given its forecasts. Using data from Morningstar, we can see that Ryder's closest peers in terms of market cap, along with their respective P/E ratios are as follows:

Company

P/E (Morningstar)

Air Lease Corp. (NYSE:AL) (USD)

11.40

Sixt SE (OTC:SXTSY) (USD,EUR)

19.80

Avis Budget Group, Inc. (NASDAQ:CAR)

7.70

Average P/E

12.97

CY16 EPS

6.67

Target Price

86.53

Click to enlarge

Source: Morningstar

By applying a peer comparable target P/E of 12.97x on the company's forecasted CY16 EPS, we arrive at a target price of $86.53 per share, thus indicating that the stock has 70.9% upside potential from the last closing price of $50.64 per share. At the current market price, the stock is trading at 7.2x CY16 earnings and is offering a forward dividend yield of 3.8%.

Conclusion

Ryder has underperformed the market over the past 12 months, falling by 44.1% (as of 22nd January closing) and underperforming the S&P 500 Index which fell by just 7.1% over the same period. Based on our peer multiple comparison, we can see that the stock in undervalued, and thus there is room for convergence in P/E multiples, which should drive the stock higher in the year ahead. Furthermore, the resumption of the stock repurchase program should also help in generating returns for shareholders.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.