Arkansas Best Company (ABFS) is, in my opinion, "stupid cheap."
As an economically sensitive less-than-truckload (LTL) carrier (for the smaller loads generally carried a shorter distance or requiring more care), ABFS has faced a perfect storm of sorts: it has faced massive economic headwinds due to the freight recession of '08 and '09. High costs and irrational pricing have killed its profitability (until recently). A recent judge dismissal of a lawsuit aimed at lowering their costs and a revenue warning last week only added fuel to the fire, dropping the stock to historic lows. And yet, with a reasonably strong balance sheet, solid management, a growing presence in attractive segments of the industry, and a strategy in place now (and being executed) to rejuvenate profitability, I believe that ABFS is a steal at less than half book value and trading at 6.6 times analysts projected 2013 earnings.
But first the chart, and then the Bear Case that got us there:
The Bear Case against ABFS
1. ABFS has the highest costs currently of any LTL carrier. ABF (a subsidiary of ABFS) is one of 2 main unionized LTL carriers in the United States, the other being YRC Worldwide (NASDAQ:YRCW). The big boys, Fedex (NYSE:FDX) and UPS (NYSE:UPS), also compete in LTL space as do other well-run companies like Old Dominion (NASDAQ:ODFL), who is currently gaining market share at ABFS' expense. While the actual wages paid by ABF aren't that much higher than these other carriers (unionized or not), ABFS' participation in several heavily-underfunded Multi-employer Pension Plans (MEPP) saddles them with extraordinary pension costs, due to their having to carry the costs on drivers covered through companies that have gone out of business or that have withdrawn from the plans (called "orphans"). ABFS estimates that as much as 40-50% of their pension expense, perhaps more than $50 million annually, are for non-ABFS drivers!
To make matters worse, the International Brotherhood of Teamsters (IBT), ABF's union, has agreed 3 times to wage/benefit concessions for ABF's closest competitor, YRC Worldwide, so even the other unionized LTL carrier has lower costs than ABF! It was this that prompted the 2010 lawsuit by ABF (see #2 below). Because of this, the raw labor costs for ABF are higher than virtually any other freighter!
2. ABFS just had a potentially game-changing lawsuit dismissed--again. Truckers usually negotiate jointly an agreement with unions, called the National Master Freight Agreement (NMFA), so that each company doesn't have to have an individual agreement. The most recent version was completed in 2008 and is set to expire at the end of March, 2013. As stated above, the IBT has made 3 different concessions with YRCW without extending those same concessions to ABF. ABF has argued (I believe correctly) that the NMFA negotiated by ABF, YRCW, and others requires that all parties be treated equally. Therefore, when YRC was granted concessions on 3 different occasions to reduce their costs, ABF argued that they were entitled to the same concessions, which cumulatively amounted to about $750 million over a multi-year period (this is the company's figure--I don't know exactly how they got it). However, a judge has dismissed the case now on 2 different occasions, the most recent being August 1, on the grounds that they "failed to exhaust the grievance procedure." ABF has decided to file another appeal believing that the grievance procedure (which is decided by those against whom ABF is alleging a grievance) is unfair. Wall Street, clearly believing that after 2 dismissals ABF has little chance of winning in court, has summarily chopped the stock price by almost 40%.
3. ABFS is facing a deteriorating trucking environment. In their last conference call, ABFS noted that they were facing more "softening in the economy." Freight is largely an economic sailboat, especially moved by the winds of a soft housing market or lower auto sales--any worsening of the economic situation or stagnation in employment only compounds the above problems. This appears to be exactly what is happening now with their warning this past week of further decreases in shipping tonnage.
4. Poor pricing during the recession. Particularly in '08 and '09, as freight tonnage slipped dramatically, frantic companies cut pricing to preserve cash flow. ABF compounded the problem by not having adequate fuel surcharges to offset the rising costs of fuel. Since then, ABF has made great progress in ensuring profitability, raising rates, and ensuring that there are adequate fuel surcharges, but the problems won't be completely worked through for likely a few more years. ABF has recently (end of June, 2012) put through some additional price increases and is focusing on profitability, but the net result has been a loss in market share.
The summary? ABF wrestles with high fixed costs in a highly competitive industry and is suffering from some legacy pricing decisions. The recent dismissal of their lawsuit combined with decreasing freight volumes has destroyed the stock price.
The Bull Case
The bull case can be easily summarized: "All that bad news? It's all priced in!!" And then some.
ABFS has a solid balance sheet and is trading for less than half book value. Book value in the most recent quarter is $18.07 (courtesy of Yahoo Finance). The balance sheet was much stronger until June, when ABFS purchased Panther Expedited Services Inc. for $80 million in cash and $100 million in long term debt. But even post-acquisition, the company has a current ratio of 1.25 and has a history of cash flowing. Bottom line is that even with the bad news above, ABFS isn't going anywhere any time soon.
ABFS is also profitable and has a history of strong profitability. Prior to the Great Recession, ABFS earned between $2 and $4 per share per year, while paying out a growing dividend that topped out at .60 per share. More recent results have been much more negative: they lost over $5 per share in 2009, $1.30 per share in 2010, and then earned back .23 per share in 2011 in their return to profitability (statistics courtesy of Morningstar). Today, management is carefully executing their plan to ensure that this trend of creating sustainable profitability continues, even if revenue is temporarily stagnated. In their most recent quarter (click here for the press release), ABFS earned .18 per share excluding special items. Last year the new ABFS (combining Panther's results with the existing operations) would have earned $123 million in EBITDA in 2011 and is on track to do better than that in 2012--all while facing the headwinds enumerated above.
I believe that, all of the bad news notwithstanding, there are multiple catalysts on the longer term time horizon for ABFS that we can be reasonably sure will occur:
1. The soon-to-be-negotiated agreement with the IBT (the union) that goes into effect on April 1, 2013 should lower their costs, probably significantly I don't pretend to have a crystal ball of know what will happen in that negotiation. But what I do know is that the IBT has been working side by side with all of the carriers in these difficult times because it is in their best interest to do so. The very YRCW concessions that have put ABF at such a competitive disadvantage during the last few years highlight this. Wall Street has priced this company as if they will never be able to get any kind of concessions at all. That could happen. But given the difficult environment extant today, I believe it is far more probable that they will get $20 to $30 million in annual concessions, and possibly more. I suspect that this will mostly come from pension benefit (MEPP) concessions and not from wage concessions.
2. The economy will improve. I am not an economist and don't claim to know exactly when this will happen. But if and when real improvement finally occurs, a rebounding housing market will increase tonnage shipped as will higher auto sales and improved commerce. A normal economy--even if it is at a "new normal" rate of lower growth--will still greatly aid ABFS and all truckers. For a long term investor with my time horizon, this is a sure bet.
3. The regional freight business will continue to grow. ABF estimates that about 60% of their freight now is regional and that business is growing. Truckers will tell you that the national business is difficult and slow-growing (at best), and that the real opportunity is in the regional freight. This trend will continue. ABF now has a regional presence from coast to coast in this highly fragmented market and has a great opportunity to grow market share once they sort out their pricing and finish weeding out unprofitable accounts.
4. ABFS has been aggressively growing their "non-asset" and "asset-lite" businesses during the last decade. The Panther acquisition effectively doubles these less asset-intensive businesses and positions ABFS in a business with much better long term prospects.
5. The Panther acquisition will also lend itself to cross-selling and new markets. Click here to view the full ABFS slide show that outlines their bull case for the acquisition. In their latest conference call, the management team talked about 3 pages of ideas they are working on to create synergies and enhance growth between the 2 companies. In every conversation on the acquisition, management reminds investors that other companies were asking ABFS to expand further into the logistics business, that they wanted ABFS to have this capability so that they could use ABFS in new ways. There will be benefits.
6. The next 2 years will give them time to fully work through the bad pricing and poorly conceived freight surcharges of the freight recession. ABFS' focus on yield over revenue will likely result in a stagnation of market share but a boost in profitability, regardless of wage costs. If, in fact, wage costs are lowered for whatever reason, then ABFS will rapidly succeed, I believe, in regaining market share in the LTL freight business.
Other Possible Catalysts
There are other possible catalysts for ABFS, ones that may or may not happen:
1. The current pension act, with the egregious provisions described above, is slated to sunset in 2014. Judy McReynolds, the CEO of ABFS, presented to congress this year and is trying hard to be influential with the parties that will draft the new provisions. It is possible that new provisions with respect to "orphans" will be enacted that will be far more equitable for companies in ABFS' position. If this happens, the positive benefit for ABFS would be significant, perhaps to the tune of the $50 million described above.
2. ABFS could prevail in their lawsuit against YRCW and the IBT. The amount asked for in damages is $750 million. I view this at this point as a long shot and do not expect it to occur. However, management feels strongly that their case has merit and for what amounts to immaterial legal fees has a risk/reward proposition that is quite compelling for shareholders in the event they prevail.
The Bottom Line
I believe that even in the absence of a legal victory in the lawsuit and with no governmental changes to current pension law, ABFS will still earn $2 to $3 per share in a more normalized economy during the next 2 to 4 years. (FYI--the average analyst earnings estimate for 2013 is $1.08, with a 12% estimated long term growth rate--numbers from Yahoo Finance). I don't need ABFS to do anything great to get to this number--they simply need to succeed at least partially in lowering their labor costs and to have a resumption at some point of a decent trucking economy, both of which I view as likely. And we will know in 6 1/2 months (likely less) if I am right on the labor costs.
From 2002 through 2007, ABFS enjoyed a PE multiple of between 9.7 and 17.4. If we use a price earnings multiple of 10, I would expect that at some point in the next five years ABFS shares would trade in the $25 range (10 times $2.50 per share of earnings), and I would be paid about a 1.5% dividend to wait. Alternatively, using a normalized 1.5 times book value would give me a comparable future value per share. Morningstar also rates ABFS as a 5-star stock with a fair value estimate of $24, a 300% increase from today's closing price, using a far more complex "dcf" methodology than I employ.
The bottom line? Those willing to wait out the current storm clouds will, I believe, be amply rewarded for their patience with ABFS with tremendous upside.
Additional disclosure: I will likely add to my long position in ABFS during the next few days.