Investment Thesis – ArcBest Corporation common stock is a short because:

¦ ArcBest is a low-quality, secularly declining business trading at 21x 2014 earnings

¦ Even using aggressive assumptions yields a fair value of about half the current price

¦ Off balance sheet liabilities are likely well in excess of the current enterprise value and could cause material impairment to equity holders

Business Overview

ArcBest is best thought of as three segments:

Long-haul Less-than-Truckload (LTL) (74% of revenue, 66% of earnings) – As the name implies, long-haul LTL transportation involves shipments that travel a fairly long distance (ARCB’s average is about 1000 miles) and are smaller than a full truckload. To consolidate these smaller shipments, ARCB operates a national network of nearly 250 terminals. As cargo moves between terminals it is not uncommon for a single shipment to be placed on 5 or more different trucks before reaching a final destination.  Most of ARCB’s freight comes from industrial b-to-b deliveries. As such, this business is highly cyclical with volume/pricing correlating strongly with measures of overall industrial production.  Almost all employees in this segment are unionized and subject to collective bargaining agreements.

Premium Logistics (12% of revenue, 18% of earnings) – In 2012 ArcBest acquired Panther Expedited Services to form what is now the company’s premium logistics segment. This is an asset –light business that offers premium services for shipments that are time-sensitive or require special handling for cargo that is fragile, hazardous or temperature controlled. 

Other Asset-Light Logistics (15% of revenue, 16% of earnings) – ArcBest also provides transportation management, fleet maintenance and repair and retail moving services.

ArcBest is a Secularly Declining Business

The long-haul LTL segment has been in slow secular decline for many years.  Moving freight via circuitous routes involving multiple truck transfers with a unionized workforce is not the most efficient system. As such, long-haul LTL is always the most expensive shipping option compared to alternatives such as full truckload or rail.  Big shippers who previously used long-haul LTL have thus found it more efficient to operate a larger network of regional distribution centers. These larger networks do not require long-distance shipments further eliminating the need for long-haul LTL.  Furthermore, a s manufacturing continues to move overseas, container shipping accounts for an increasing share of trade. Once a container arrives in a U.S. port it is much more efficient to move the entire container by rail rather than truck using a system known as intermodal.  Intermodal now accounts for much of the work that was previously done by long-haul LTL.

Figure 1: Secular Decline of Long Haul LTL

Multiemployer Pensions are a Massive Off-Balance-Sheet Liability

Nearly all of the company’s unionized employees are entitled to pensions and retirement healthcare provided by multiemployer plans. Multiemployer pensions require several different employers contribute to plans for employees of the same union. If one employer leaves the plan and stops contributing, the remaining companies assume that liability. An individual employer’s contributions are determined in negotiations with the unions.

On balance, multiemployer plans have been a disaster. According to a 2012 Credit Suisse report, multiemployer plans had a deficit of $369B with the average plan only 52% funded. While it’s impossible to know ARCB’s exact multiemployer liability, using one common method to estimate an individual employer’s share shows ARCB’s debt to just the Central States plan alone is about $4B (calculations shown in figure 2 below).  The Central State’s trustee has been quoted saying the will run out of money in about 10yrs, so this issue will need to be dealt with in a reasonably short time.   Of course ArcBest’s burden could be reduced via some type of government bailout or benefit cut, but it seems unreasonable to assume that taxpayers or retirees get hurt without ARCB having to contribute meaningfully.  So while it’s not clear what will ultimately happen, whatever the outcome it will likely not be good for ARCB.

Figure 2: ARCB Estimated Liability for the Central States Pension Plan ($ in millions)

ArcBest is Overvalued Even When Using Aggressive Assumptions

Cyclical businesses such as ARCB should be valued using a justified multiple of mid-cycle earnings.  2014 will be the 5th year of growth in the current business cycle. Given the general length of a business cycle and current economic data, I believe it’s aggressive to assume 2014 is a “mid-cycle” year.  However, even using this rather aggressive assumption and supposing no secular decline or multiemployers pension liabilities, ARCB is still 40% overvalued. Using more realistic assumptions implies over 60% downside.

Figure 3: Over 40% Downside Using Aggressive Assumptions

The Stock is Fairly Valued Even in a ‘Best Case’

2015 earnings estimates assume record pricing and continued growth in margins and volume. Even so, volume is expected to remain below the last cycle peak (2005/2006) due to the secular issues noted earlier. However, even if volume returns to these all-time-high levels, ARCB shares still only appear fairly valued.

Figure 4: ARCB is Fairly Valued Even in a Best Case

Risks

Liquidation of Largest Competitor (YRC) – ArcBest’s largest competitor (by far) is YRC Worldwide. During the last cyclical downturn YRC faced serious liquidity constraints and was forced to restructure with both creditors and employees. While these issues have now resolved, if YRC is forced to liquidate in the future this could send a lot of business to ARCB.  However, I view a YRC liquidation as a very low probability. Since the liquidated assets have little value both the unions and creditors are much better off with YRC as an operating business and both have shown a willingness to make concessions when necessary.

Overall Economic Strength –  “Normalized” or “mid-cycle” earnings means the amount a company would earn adjusted for the ups and down of a business cycle. Even though this is theoretically correct, it is often difficult to know what mid-cycle actually looks like. While I have reasonable conviction that the numbers I am using are well in excess of true mid-cycle levels, if medium-term economic growth is much stronger than anticipated, these numbers could prove to be below the actual mid-cycle levels and thus intrinsic value would be higher than I’ve estimated.