Ryder Systems (R), the largest U.S. truck lessor, has been making headlines since it was upgraded by Sun Trust Robinson Humphrey. For quite some time, the stock has been on Qineqt's buy list, given its potential to be a major beneficiary of the shale gas boom. The stock has been upgraded, not because of a rise in revenues, but a decline in operating costs, as management is working hard to adjust the capacity for what seems to be a dark year for the transportation industry. The stock is trading at cheap valuations compared to other transportation stocks, declining costs, earnings at lesser risk due to declining headcount and optimal inventory levels - all these factors make it evident why this is one of Jim Cramer's favorite stocks.
In the second quarter's earnings release, the company topped earnings estimates, but, once again, missed revenue estimates, reaffirming how the transportation industry has not been able to meet the Street's expectations. The earnings of $1 per share were up 14% YoY for the second quarter. The shares went up a day after the announcement, when management boosted its earnings outlook for the next quarter as well as the next year. Management now expects the company to make EPS of $1.15-$1.22, rather than the earlier estimate of $1.09. The earnings estimates were revised after the company decided to take cost management actions in anticipation of a challenging environment in the near future.
The overall revenue rise was 3% YoY from $1.5 billion to $1.56 billion. The company generates its revenues from the following functions:
Supply Chain Solutions (SCS)
SCS offers logistics management services that help optimize the customer supply chain. The dedicated contract carriage services come under this segment, in which the company ensures the transformation of materials from their raw form to the final product.
Revenues for this segment were up 6% YoY, while operating income was up 9%. The business benefited significantly from increased automotive volumes. Also, the rise was a bit exaggerated after weak automotive transportation results last year due to the tsunami in Japan. The future seems bright given the strong sales figures for SAAR in the last two-to-three months. September's solid SAAR of 14.9 million, which was significantly above the Street's estimate of 14.5 million, has sent a bullish signal to the market.
Fleet Management Solutions (FMS)
FMS is a combination of different offerings. It provides outsourcing of acquisition, financing, maintenance, management and disposal of vehicles. Its most important sub-segment, commercial rental service, offers a package to companies through which they can increase their fleets in order to address short-term capacity needs.
Revenues for this segment increased by 3% YoY. Fuel service revenue is one of the important drivers of this segment. Lower fuel prices for the quarter meant lesser fuel prices being transferred to customers. Profits for the segment were up 7%. A 5% YoY increase in full service was also witnessed. This improvement was because of organic fleet growth and the Hill Hire acquisitions in 2011. Hill Hire is a U.K.-based truck leasing company. Commercial rental revenues also increased by 10% due to favorable pricing policies.
However, the future may not be bright given the tough macro conditions that have dented the overall freight tonnage in the economy. The Cass Implied Freight Index was down by 1.1% in August YoY.
However, bulls have another strong argument. They argue that the movement in rentals at Ryder is a good indicator of the economy's pace. The overall rise in rentals of 6% shows that the economy has started to move, but the companies are still reluctant to invest in new or replacement trucks, and therefore, prefer rental truck services to move their merchandise.
Sun Trust Robin Humphrey upgraded the stock from neutral to buy, with a price target of $48, which means a 14% upside in the stock at the current price level. The main reason for this is that the stock is trading at very cheap and low-end multiples, as the general perception in the market is that the company will be one of those that will announce lower earnings for this quarter, given the decline of the overall transportation industry.
The graph shows that Ryder has been underperforming the Dow's Transportation Index YTD. However, this does not tell us much about the future movement of the stock.
The forward P/E of 9x is just slightly above its five-year low multiple of 8.6x. Suntrust believes that the market was correct in predicting that transportation was headed for another challenging year. However, it is the cost part of the equation that will boost the stock price. The company is aggressively reducing its headcount and managing its inventory smartly, which means that Ryder's earnings are not at risk for this quarter at least. Along with this, the leaner cost structure and the company's young fleet are further upsides for its business.
Ryder has been one of the very few companies that have been pressing for stringent regulations within the trucking industry. This is because the more regulations, the more the people would like to avoid complexity, and will outsource their businesses to Ryder. Ryder will take all that complexity off their customers' hands for a price that is essentially the rent - their main source of income. The regulations have definitely risen over the past couple of months. For instance, trucking policy and regulations unit TPRU is working to ensure the safety of the public by developing motor carrier regulations.
In such a situation, acceleration in customer growth will lead to a jump in the stock price.
Opportunity to benefit from Shale Gas Boom:
The company has been getting more and more natural gas trucks. In March, the company leased as many as 250 trucks nationwide. Although the rentals from the trucks do not form even 1% of overall revenues, the company still has a huge opportunity to benefit from the cheap source of fuel.
The stock is trading at cheap valuations. Currently, it is down 20% YTD. As already mentioned, the forward multiple of 9x is near the lowest in five years. CAPEX is on a rise. The expansion is due to planned investments to fulfill the full service lease sales to customers that are renewing their fleets. Cash flows remained flat for this quarter YoY at $472 million. The free cash flows are expected to rise due to a sale-leaseback transaction, recently executed by the company. With cheap valuations, effective inventory and human resource management, and a dividend yield of 3%, Ryder is recommended as a buy.