Description

We are pitching the #6 less-than-truckload (LTL) carrier, ArcBest (ARCB), as a long.  Cyclical small caps are a scary place to be right now but we think this will at least double over the coming cycle due to cheap valuation, a likely cyclical trough, and a secular kicker from the bankruptcy of a large competitor.  

The key points to the thesis are:

• The trucking industry is 18 months into an ugly downturn, leading indicators suggest we are approaching a bottom

• Yellow, the prior #3 player, filed for CH11 bankruptcy in August, while this has obviously been digested by the market most sensitivity analysis we have seen from the street focus on the volume uplift and ignore the likely pricing increases this will also support

• ARCB to us is remarkably cheap vs peers, it trades at 10x 2024 EPS vs the other unionized carrier TFII at 15x, and the non-unionized players at 25-30x

• There is a lot of operational leverage in the model but the financial leverage is minimal with a net cash balance and a track record of FCF generation

A brief company description:

A mentioned above, ARCB is the #6 LTL shipper in the country.  They also have an asset light freight forwarding business which is important on the top line but less impactful to earnings.

Comps in the asset heavy space are SAIA, ODFL, XPO, and TFII.  While the asset light players are CHRW, JBHT, FWRD, etc.

One important note here is the company is unionized, along w/TFII and Yellow (while it was alive).  There is a clear cost disadvantage that comes along with this and it shows up in their OR which is slightly more than 2000bps worse than the industry leader ODFL.  That being said, they signed a new 5 year deal over the summer which has now been baked into #s and should not be an overhang for the foreseeable future.

The cycle:

Trucking is a cyclical business so where we are in the cycle should typically be question #1.  Our view is that we’re pretty close to a bottom.  If we get a consumer led recession in 2024 there could be an incremental leg down, but this feels like a good moment to dip a toe in.

LTL volumes (see below) have been negative for the past 6 quarters, which is about as bad as it’s been since the GFC.  Industry volumes are driven by industrial shipments and retail mostly, both of which have been unwinding for the past year (again, see below).  It’s important to discuss pricing here because it will likely be a point of contention from bears.  Despite lower volumes the industry has been highly rational with pricing over the past year or so which has defied gravity versus the truckload industry.  We have been skeptical in the past and were proven wrong.  But we’re able to gain comfort there won’t be any price give back in the intermediate term due to the Yellow BK.

On the asset light side of the business, the most important metric to watch is spot truck load pricing, which is off about 50% from peak.  The last shoe to drop here is typically capacity exiting the industry, which admittedly we haven’t seen yet, but spot margins dictate that we likely aren’t far away from it.

Yellow’s BK:

This is been in the making for years but it came to a conclusion in August.  See below for their market share, the volume implications are pretty straightforward for the remaining players.

A few things to note:

• While the sell side published a lot of notes on the impact of increased volumes not a lot of them assumed a price lift which will almost certainly happen given Yellow was at the bottom end of the industry pricing bucket

  • If you run the math and ARCB gets their “fair share” of volume from Yellow that adds $40m to EBIT, if you run 5% extra price through their system its an incremental $145m of EBIT….which adds up to about $5.75 of incremental earnings on a base of ~$7.00

    • And this doesn’t assume any improvement from volumes in the overall system

  • Being a unionized carrier ARCB is actually in pole position to collect the best drivers from Yellow

  • A lot of how Yellow’s demise plays out over the medium term will depend on who buys their terminals (industry good, private equity bad)

Valuation

• I have ARCB earning $10.00 in 2024 (less aggressive than the scenario above) and $12.00 in 2025…..I have assumed a similar ramp for the other industry players…..there is no assumption for improved macro volumes baked in for 2024 and very modest LSD tailwinds in 2025 which could prove conservative….ARCB is trading at 10x vs TFII (unionized) at 15x, XPO 25x, SAIA 28x, and ODFL 30x….on the asset light side CHRW trades at 20x, JBHT 21x, FWRD (which is a special sit now) 14x….to us ARCB sticks out like a sore thumb

• Our target in 2024 is $180, that basically assumes they get valuation parity with TFII at 15x the out-year number, although I believe this could be conservative if the macro bottoms out and our numbers prove conservative

Risks

• Their Q3 results will likely be inline/worse due to weakness in the asset light business while the rest of the LTL group should be inline/better

• A severe 2024 recession

• Yellow’s terminals quickly falling into the hands of a financial buyer causing price com

Catalyst

• confirmation of a bottoming in volumes
• industry commentary on pricing post-Yellow