Covenant Logistics: Data Analytics To Hire Drivers Could Push The Price Up

Summary

• Covenant provides expedited light-duty services.
• In my view, the use of technology may help explain recent efficiency increases in the average freight revenue per total mile and the average freight revenue per tractor per week.
• I am optimistic about continuing with the improvements and optimizations in the security area of ​​the company.

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Covenant Logistics Group, Inc. (NASDAQ:CVLG) continues to deliver improvements in efficiency with larger average freight revenue per total mile driven and further investments in technology. In my opinion, if data analytics continues to enhance the evaluation of recruiting spending and the identification of driver candidates, FCF generation will likely continue. Yes, there are risks from new environmental laws and lack of labor supply, however, I believe that the stock price could be worth a bit more.

Technology Appears To Be A Driver Of Business Growth

Founded in 1986, Covenant provides expedited light-duty services. This business began with a model of two carriers per fleet for each trip, with a total of 25 trucks that to date have grown to more than 2,000, providing a nationwide distribution and logistics line for its customers.

Covenant's current objective is to position itself as a key service provider in the supply chain of its clients, besides ensuring long-term contracts and activity without depending on seasonality or demand at any given time.

Of its more than 2,000 trucks, 900 are in use in the expedited cargo segment while the rest are available for the dedicated cargo segment. The accelerated cargo segment means 33% of its total operations, 31% for logistics and management services, and 28% for dedicated cargo.

Covenant's truck fleet has an average age of 2.8 years compared to an average of almost 7 when it comes to the market in the United States. This is undoubtedly a competitive differential in a market that has changed substantially in recent years due to the modernization and technology of the offer as well as the specific demands of clients.

Covenant has a series of technologies that it applies to its business model. These include load and route optimization software, a tracking and communication system that allows permanent contact between customers, carriers, and the company, electronic registration devices in all its trucks, aerodynamic improvements, and transport maintenance. In my view, the use of technology may help explain recent efficiency increases in the average freight revenue per total mile and the average freight revenue per tractor per week.

10-K

The business model is divided into two segments, both related to cargo transportation, the segment of accelerated loads and the segment of dedicated loads. These operate primarily within the United States through company-owned assets or leased transportation from independent contractors. The expedited cargo segment offers transportation in a timely manner, adapting to the route and schedule, without an agreed routine. The dedicated cargo segment, on the other hand, serves the customers who have cargo already agreed by route and schedule with the company.

Payments are commonly made by distance in miles traveled plus added services such as loading and unloading of merchandise as well as other specialized services. Covenant's calculation for profit evaluation includes profit per load and mile, profit per truck, and profit per truck per week.

Assets

In December 2022, the company reported cash worth $68.665 million, accounts receivable of $119.770 million, drivers advances and other receivables of $3.798 million, and inventory and supplies worth $3.516 million. Also, with prepaid expenses of $15.746 million and assets held for sale of $5.956 million, total current assets stand at $222.656 million. Current assets are more than 1x the total amount of current liabilities, so I would say that Covenant does not report significant liquidity issues.

10-K

Net property and equipment stood at $407.735 million with goodwill worth $58.217 million, other intangibles of $48.169 million, and other assets of $58.843 million. Finally, total assets stand at $796.645 million, close to 2x the total amount of liabilities.

10-K

Accounts payable stood at $33.896 million, with accrued expenses of $50.984 million and accrued purchased transportation of $7.779 million. Besides, current maturities of long-term debt stood at $18.897 million in addition to a current portion of finance lease obligations of $5.326 million and a current portion of operating lease obligations of $18.179 million. Total current liabilities stand at $156.121 million.

10-K

The total amount of long-term debt stands at $90 million, with deferred income taxes of $98 million and total liabilities of $419 million. Considering my expectations of free cash flow, I believe that the net debt does not seem scary.

10-K

Assumptions Under My Cash Flow Model

Under my DCF model, I assumed that Covenant would successfully undertake its 7 key point plan to carry out its growth strategy, aimed at making the company's services a fundamental part of its clients' supply chains. This plan includes the experience and improvement of the service, strengthening the relationship with both the drivers and clients, a capital allocation process evaluated in what corresponds to investments and acquisitions, and mitigating to the maximum the possible risks of management and operations.

I also believe in further technological developments for its transports and communication systems and analysis of logistics and shipments. I am optimistic about continuing with the improvements and optimizations in the security area of ​​the company. In the most recent annual report, the company provided the explanation about the software developed internally and the technology acquired.

We purchase and deploy technology that we believe will allow us to operate more safely, securely, and efficiently. Our operational information systems are tailored to the needs of our various service offerings, utilizing software developed internally and purchased off-the-shelf depending on the operational needs. We will continue to seek out technology to improve efficiencies and expand our resources while still providing enterprise wide visibility for critical operating functions. Source: 10-K

My Cash Flow Expectations Implied A Valuation Of $44-$47 Per Share

I foresee 2023 net income of $28.107 million together with a provision for losses on accounts receivable close to -$2.250 million. Additionally, the D&A would be $34 million with deferred income tax benefit close to -$18.339 million. Also, with 2033 stock-based compensation expenses of $6 million, I included a gain on disposition of property of -$49.193 million.

Expectations From Malak

2033 prepaid expenses would be close to -$3.953 million with inventory and supplies of $0.149 million and 2033 changes in accounts payable of -$35.561 million, which implied CFO close to $75 million. Besides, with a 2033 capex of $37.950 million, 2033 FCF would be $37.95 billion.

Expectations From Malak

My CAPM model includes a beta of 0.95, cost equity of 11.5%, a tax rate close to 25%, and a cost of debt close to 5.6%, implying a WACC of 10.80%.

CAPM Model From Malak

If we assume 2033 free cash flow of $39 million, an EV/FCF multiple of 6.7x, and a WACC of 10.80%, the enterprise value would be close to $649 million. Besides, with cash of $68.665 million, current debt of -$18.897 million, finance lease obligations of -$5.326 million, and long-term debt of -$90 million, equity would be $597.157 million, and the target price would be close to $44-$47.

Expectations From Malak

Competitors And Risks

Competition does not only come from local independent contractors, but also from rail freight transport and other types of ground transportation services. In the last year, the market has experienced a decreasing demand due to several reasons, among which are the volatility of the price of fuel and the low workforce of specialized personnel. I believe that trains and other types of transportation companies that don't require fuel to move may obtain clients from Covenant.

Covenant believes that the oil price increases and a low workforce of specialized personnel may last until the middle of the year 2023. With that, management appears confident in its ability to adapt and reduce costs so as not to be affected in its operations.

In my view, failed market readings and allocations of available capital are short-term risks. In addition, the decreasing demand in the current economic environment for 2023 may harm future net income growth.

Besides, there are a large number of regulations that exist in the transportation market, which in the future could negatively affect the operations of the company. In my view, new environmental laws against the use of gasoline and increasing taxes could bring future free cash flow expectations down. As a result, if investors decide to sell their shares, I believe that the stock price could decline.

Finally, I believe that issues from the relationships with independent contractors could damage the brand of Covenant, and lower future free cash flow expectations. In particular, if these contractors fail to receive financing, perhaps the prices charged to Covenant could increase, which may lead to higher costs. Management offered more cases in this regard.

As independent business owners, independent contractors may make business or personal decisions that may conflict with our best interests. For example, if a load is unprofitable, route distance is too far from home, personal scheduling conflicts arise, or for other reasons, independent contractors may deny loads of freight from time to time. Additionally, independent contractors may be unable to obtain or retain equipment financing, which could affect their ability to continue to act as a third-party service provider for the Company. In these circumstances, we must be able to deliver the freight timely in order to maintain relationships with customers, and if we fail to meet certain customer needs or incur increased expenses to do so, this could materially adversely affect our relationship with customers and our results of operations. Source: 10-K

Conclusion

In my view, if Covenant successfully continues to invest in technology to execute data analytics to identify driver candidates, evaluate recruiting spending, or design tractor specifications, FCF generation will likely continue. Besides, I am optimistic about future improvements in average freight revenue per total mile because I expect further expenditures in technology. Yes, there are risks from further increases in the price of oil, labor law changes, or lack of labor supply, however the stock price, in my view, appears too cheap.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CVLG either through stock ownership, options, or other derivatives. 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.