Description

Ryder Systems has three business units: (a) full-service truck leasing and rental, (b) dedicated contract carriage (which is similar to truck leasing but also provides drivers and routing), and (c) supply chain logistics. R's shares trade below book value and at a low p/e multiple (although recently reported earnings have been somewhat of a "mirage" as the company benefited from abnormally high pension gains and understated depreciation of trucks).

The full-service lease business (which is growing as companies outsource their truck purchasing, servicing, licensing, disposal, etc.) competes with #2 Penske (a subsidiary of GE who recently acquired #3 Rollins), and numerous smaller competitors, most of whom lack economies of scale, have a higher cost of capital, etc. The continued investment by GE into the truck leasing business (through its 2001 acquisition of Rollins and 2000 acquisition of Rentway) supports my belief that the industry possesses good fundamental business characteristics. Recently, this unit has underperformed due to the weak used "class 8" truck market (which has left R with too many trucks, thus leading to higher than normal depreciation and interest expense and reduced residual gains). The weak "class 8" truck market is a phenomenon caused by the poorly executed Union Pacific-Southern Pacific merger, which lead to massive rail congestion and thus a preference by shippers to shift shipments to trucks; the surge in demand for long-haul trucks resulted in oversupply once the Union Pacific fixed its problems and traffic shifted back to the rails. Thus, the oversupply of used trucks is a temporary phenomenon that should improve in a year or two. After analyzing the different types of trucks in Ryder's portfolio, Ryder's new method for depreciating trucks, and the average maturity of current leases, I estimate that the potential write-off should be about $2.50 per share.

Supply Chain Logistics is a non-asset intensive, high growth business that is benefiting from the trends of outsourcing, globalization, and JIT manufacturing. Recently, the industry has been consolidating as customers look for logistics providers with global capabilities. CTI Logistics (a unit of CSX), which appears to be very similar to R's logistics business, was recently acquired by TNT-Post Group for 16.3x 2000 EBITDA, or $650MM. Many European companies -- including Deutsche Post (the recently privatized German Post Office), TNT-Post (the former Dutch Post office), and Exel plc. -- have stated their intentions of expanding their logistics businesses through acquisition; UPS is also interested in growing its logistics business through acquisition. Thus, R's supply chain logistics unit would certainly seem an attractive asset.

Dedicated Contact Carriage is another Ryder product offering that is part of, and supports both Truck Leasing and Supply Chain Logistics. This segment only represents a small portion of the overall value of Ryder, and thus it isn't worthwhile to discuss specifics. Ryder also has several e-business solutions ventures.

R's current mix of businesses presents a conundrum: while "growth" investors are willing to pay high multiples for logistics companies, they might avoid buying R shares because the company also has the slower growth leasing business; conversely, "value" investors see R's shares priced at an attractive price but are unwilling to "step-up" their multiples because they are unwilling to give full credit to the implied value (based on comparable logistics companies) of the logistics unit. Management now realizes this problem and is investigating solutions to unlock this conglomerate discount.

Management recently introduced an aggressive restructuring plan which aims to achieve a 13% ROE in 2002 (implying eps of approximately $3.00) and an 18% ROE in 2003 (eps of approximately $4.50). If R is capable of achieving a ROE anywhere near these levels (the ROE today is around 8%), the shares should appreciate substantially.

Ryder is best valued as a sum of its parts. Valuing (a) the non-asset based businesses on an EBITDA multiple basis minus segment debt and (b) the asset based business on tangible book value plus a portion of deferred tax liabilities (which are more than $16 p/s), I conclude that R's shares should be valued at more than $30.

Catalyst

New management's aggressive cost reduction program, improvement in used truck inventory levels, possible sale of logistics division or sale of company, attractive valuation.