Con-Way (NYSE:CNW) released earnings on Wednesday night which fell short of consensus estimates and reduced guidance for the full year. The Company cited what everybody in the trucking industry has been feeling: a combination of a soft freight environment coupled with weakening prices. From all indications, the second half rebound that gurus on Wall Street were expecting seems to be dead and expectations seem to be coming in, with a 2009 recovery the new mantra amongst the crowds.
All this brings me to a very interesting short idea. YRC Worldwide (NASDAQ:YRCW) is the largest LTL carrier in the industry. LTL for those of you not familiar with trucking parlance stands for Less-Than-Truckload. Carriers such as YRC Worldwide consolidate multiple loads from various shippers into one tractor / container and haul it to a distribution center where it is unloaded, sorted and then delivered to the final destination.
I will attempt to identify why YRC today represents a compelling short opportunity.
Operational Issues / Setbacks: - YRC has struggled to integrate it’s acquisition of both Roadway and USF. In early January, the Company decided to take actions by shuttering terminals in its regional operations. The Company today operates its subsidiaries as standalone entities with no integration whatsoever. This is intentional and is aimed at preserving the brand equity of Yellow, Roadway and the USF brands. How sane this idea is, I leave it up to you to decide. Management turmoil has been another issue with YRC with a couple of recent departures amongst its key executive ranks.
Weak Freight Environment: - With a weak freight and ongoing operational turmoil, other LTL carriers are starting to pick away at YRC’s market share, which can cause the Company to undercut on pricing to preserve volume at the expense of yields which can have a significant impact on its operating profitability. Con-Way on its conference call highlighted increased price competition in the LTL space, and indicated a major carrier to be involved in price competition. By law of elimination, the most obvious identity of this large player is YRC. More on that later.
Financials: - The Company in a recent investor meeting highlighted that the continuing soft freight environment continues to impact its business. When asked about specific trends, the CEO highlighted that Q1 was shaping up to be very much like Q4, 2007. If that is any indication, than Q1 is going to be an unqualified disaster. Additionally, the Company was quick to point out that adverse weather conditions were also playing a major role in impacting its operations in Q1.
We all know what it means when management starts blaming the weather. The Street expects YRC to lose money in Q1, but I believe the miss can be significantly greater than what analysts are currently predicting. Ok so what if they miss, eventually the freight environment is going to turnaround and they being the largest player will be the greatest beneficiary of such a turn. Right? Wrong. This unfortunately is what many on Main Street and Wall Street are predicting.
However, one very important component of the YRC story is leverage. YRC has about $1.2bn of debt on its balance sheet as of December 31, 2007. There is a credit agreement in place that was effected in August of 2007 that provided the Company with access to capital. However, that capital comes with some constraints including a debt covenant of Debt / EBITDA of 3.0x on a trailing basis. This is a maintenance covenant meaning that the Company cannot exceed its debt level beyond 3.0 times its trailing EBITDA at any time.
Ok, so what? Well with a dismal Q4, 2007 and an equally if not worse Q1, 2008 expected, the Company can be very close to breaching its covenant. With Con-Way confirming that the remainder of the year is going to be nothing to write home about, all of a sudden we find YRC walking a fairly thin line. Given that YRC is the largest carrier in the LTL industry, I do not think that the Banks that lent money to the Company will force it into bankruptcy if it were to default on its covenant. However, they may alter the terms of the credit agreement and increase the interest rates they currently charge. (Please see credit agreement filed in August, 2007 for further details.) or secure their capital against YRC’s facilities etc.
Additionally, YRC has $225 million of debt coming due in December, a $40 million acquisition payment due sometime between Q2 and Q3 of this year and a refinancing of its ABS facility in May. With a challenging macro environment coupled with continued operating struggles, I believe that there is a good possibility that the Company does not generate any free cash flow this year. Further, if tough freight conditions continue, bankruptcy could suddenly not become a remote possibility. If what happened with Bear Stearns was any indication of the severity of a run on the bank, shippers seeing that their carrier is in financial distress can pull their freight and take it elsewhere. Such a situation can be the death knell as the reverse operating leverage can very quickly end the fortunes of the Company.
When YRC shuttered some of its terminals earlier this year, some shippers were quick to pull their freight away from YRC citing uncertainty regarding its operations.
So can someone acquire the Company and turn it around? Sure someone can, but the question is will they and if so at what price. YRC has an off balance sheet liability of $3.5 - $4.0bn dollars related to its participation it the Central States Pension Fund. UPS which was also a contributor to this fund recently forked over $6.0bn in cash to get out of this program. Thus whosoever decides to acquire YRC would have to bake that into the purchase price. So now let’s do some very basic financial modeling to get at YRC’s current valuation.
Share Price: $13.84
Shares O/S: 56.658
Total Market Cap: ~$784 million
Less: Total Cash: $58.2 million
Add: Total Debt: 1.2 billion
Add: Total Pension Liability: $3.5 billion (let’s use the lower number of the range.)
Enterprise Value: $5,425.8 billion
EBITDA (2008E Reuters Estimate:) $478 million
Thus YRC trades today at 11.4x Forward EBITDA. You have to include the pension liability when doing the calculation as this is how any strategic or financial buyer would value the Company.
Con-Way, a well run Company prior to last week’s haircut was trading at 5.7x Forward EBITDA. Go figure!
Thus in conclusion, YRC is one truck that I would stay far away from. Somehow, a struggling Company operating in a tough freight environment at a robust valuation does not seem too appealing for me to go long. Please do your own diligence.