Forward Air Corporation
Often times there are excellent businesses operating in industries that are either difficult to understand, obscure or unattractive. Sometimes good investments can be found in these regions precisely because of these factors as many investors don't take time to understand specific businesses or they simply don't know they exist. For whatever reason, certain industries are often overlooked and when this happens - value can often be found. One such industry in my opinion is freight logistics - including freight consolidation and freight forwarding.
Even though the big names including UPS and Fedex (NYSE:FDX) are known worldwide - the logistics universe is much more nuanced and is home not only to highly efficient but prosperous operators including CH Robinson Worldwide (NASDAQ:CHRW) and Expeditors International of Washington (NASDAQ:EXPD) - two companies that have produced excellent results and solid dividends for shareholders over the course of their history. A smaller company focused on air freight logistics that has recently caught my interest is the Forward Air Corporation (NASDAQ:FWRD).
Examination of Forward Air reveals that it has many of the same qualities of both CH Robinson and Expeditors - except it is much smaller than both. I believe the Forward Air Corporation represents an advantageously situated play in the air freight market.
The Numbers on FWRD
With a market cap of $1.16 Billion, almost no debt, $2.37 of cash plus $12.70 of book value against a current price of $38.53 - FWRD trades at a considerable premium to its tangible assets - however this is the norm for companies in logistics industry as both CHRW and EXPD both trade at considerable multiples. With a dividend yield of 1.1% and a payout ratio of .21 - FWRD does reward shareholders albeit in a parsimonious fashion - however this might not be that big of a problem If the company is able to retain and compound its earnings internally at the rate that it has in the past (in 2012 the return on assets was 14% - a rate that is much higher than the risk-free alternatives investors could place their cash dividends into).
What Type of Business This Company Does
The Forward Air Corporation operates in two segments and provides logistical services to handle overnight, next day, and multi day delivery to a network of airports throughout the United States utilizing ground transport. Per the companies 10K, in 2012 - 23.9% of the company's freight was for overnight delivery, 61.3% was to be delivered within two to three business days with the remaining amount longer than four business days.
The company also does not compete directly with UPS or FEDEX, instead their Airport-to-Airport forwarding services are marketed to freight-forwarders, passenger and cargo airlines. In contrast to UPS or Fedex, Forward Air also does not employ size restrictions on its cargo - which prevents it from competing in the small-parcel sector dominated by the largest players in the market. In 2012 the average shipment weight was 637 pounds, a far cry from many of the parcels which are delivered by Fedex or UPS.
Forward Air has also been able to thoroughly diversify its customer base - which in my opinion is critical for revenue stability and reduces the risk that the loss of a single major customer could produce a permanent impairment of company earnings. In 2012, the company's 10 largest customers produced 47.2% of Forward Air's operating revenue with no single entity accounting for more than 10% - statistics which I am very happy about given the dangerous nature of overconcentration or excessive reliance upon a single customer.
The company is also a lean enterprise that operates with almost no debt and does not own large amounts of equipment - instead purchasing its transportation from other companies. The ability to purchase transportation instead of maintaining a fleet of equipment, vehicles and personnel provides critical flexibility to respond to changing weather and other conditions that could otherwise impede the flow of time sensitive shipments.
As a service company trading at a premium to book value plus cash, it is important to understand what will adversely impact this business in order to make an informed purchase and mitigate the risk of capital loss. First and foremost, this company generates its revenue off of commercial activity in the United States. If there is a broader decline in commercial activity - as seen during the financial crisis - the company's revenue will suffer. However - I believe that investors should not despair about this as there is considerable opportunity to be had during these periods to purchase an efficient enterprise with no debt at a fair price.
The company is also at the mercy of high fuel prices - because it purchases its transportation needs, the company must accept the terms offered by the transportation companies that it contracts with and has not utilized a hedge of any type. Though it is likely able to pass some of these costs onto customers in the form of higher rates charged per pound - such activity could adversely impact the companies profitability. In addition, the company's labor force is non-union and if this status changes I believe the potential impacts on the profitability of the enterprise would be considerable.
From a perspective of the stock and not the business - the company trades at a relatively light volume (less than 100,000 shares on average) and this light volume could be easily punctuated by aggressive buying or selling on the part of large holders or funds - producing large anomalous fluctuations and in turn creating opportunity for investors seeking to establish or add to their holdings.
Acquisition Potential: A Two Way Street
I think that FWRD would be a good acquisition target for several reasons. It's business model is lean, and it carries no debt - in addition the company has good free cash flow - because of these three factors I believe that a larger company in the logistics sphere seeking to diversify its operations could purchase FWRD or that FWRD could purchase smaller companies to create more synergies in the air transport industry - in addition the companies free cash flow could also be utilized in concert with debt financing to buy back a significant amount of stock in order to enhance shareholder value.
An interesting facet of the logistics sector is that many companies have no debt, large cash reserves or the ability to generate a large amount of free cash flow - indicating considerable potential for a large accretive acquisition. I believe that it is possible for FWRD to be acquired by a large logistics company including J.B. Hunt (NASDAQ:JBHT), CH Robinson or Expeditors International. These three companies are both much larger than FWRD and specialize in logistics co-ordination. Of these three companies, I would see a potential acquisition from Expediters as being the most natural as the company has a large amount of cash in reserve and one of its business segments is "domestic time definite transportation services" - a service which FWRD specializes in.
Looking down the food chain, an interesting company that has the potential to contribute to FWRD's business is Universal Truckload Services Inc. (NASDAQ:UACL). With high levels of insider ownership (at 82% currently) and a similar asset return profile as FWRD (in addition to a liberal dividend policy, having paid significant annual dividends in two of the past three years).
Watch the Entry Point
One of the difficulties I have experienced with investing in logistics companies is finding a compelling entry point. Due to the fact these companies operate without significant debt and often demand higher premiums because of the innate profitability of the enterprise, it is often impossible to find a "cigar butt" in this industry. This is not a bad thing however, as Buffett has always said that it is "better to buy a wonderful business at a fair price."
At these current levels, I would not be a buyer of FWRD. I love the business but I don't love the price. I believe that if the company were to fall closer to the $30~32 dollar range it would represent a significant bargain to investors. Another event that would make me a buyer of FWRD is if macro-economic factors cause a decline in business activity. While in the short term a slower economy would translate into lower earnings for FWRD, I believe that in the long term the company will remain profitable given its steady increase in pounds of freight transported per year, its diversified revenue base, strong balance sheet and the ability to remain profitable during the last financial crisis.
The Rise of E-Commerce and Why I'm Bullish Longterm on FWRD
One of the most interesting things to come out of the widespread development of E-Commerce is the growth of services including "next day" or expedited shipping offered by companies either attempting to enter or remain competitive within the space. As more companies compete within the space and as consumer habits continue to change - I believe that there will naturally be a corresponding increase in air traffic - making time sensitive transport of consolidated freight to and from airports of substantial and growing importance within the United States.
I am of the belief that FWRD furnishes investors with the opportunity to harness and profit from this trend going forward, as consumers begin to order more and heavier items. FWRD will be able to form relationships with merchant companies and will have the ability to both consolidate large amounts of customer orders and to transport them rapidly to airports where they will be shipped.
For investors seeking an obscure yet promising company, FWRD merits an addition to a watch list. The strong balance sheet, diversified revenue base and niche business indicates the enterprise has been and will continue to be extremely profitable over the long haul. In spite of these attractive qualities, I also believe that investors must be careful about the purchase price - and while paying a premium on the company's assets is likely to be inevitable it is important to buy this company at a "fair" price.
Disclosure: I 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.