Description

SCS Transportation(SCST) is a recent spin-off from Yellow Corporation(YELL). At $6.85/share the MC is $100million and the EV is $218million. Trailing EBITDA is $69.5million and trailing FCF is $44.3million, thus EV/EBITDA is 3.1x(50% of it’s closest competitor) and EV/FCF is 4.8x.

A little background on the business: SCST is a trucking company, dealing mostly with the regional LTL (less than truckload) business. The company is divided into two operating subsidiaries, Saia and Jevic. Saia is the larger of the two with $485million in revs in 2001 while Jevic had $286million. All employees of both divisions are non-union.

YELL spun-off SCST for all the standard reasons: they wanted to separate YELL’s union employees from SCST’s non-union employees; they wanted to allow the companies to compete in their markets more effectively; and they wanted the respective management teams to be able to better focus on their operations. In reality, YELL wanted to get rid of their regional carriers and keep their more-lucrative long-haul carriers to make their results looks better. They also saddled SCST with more than their share of debt: SCST contributed about 1/3 of YELL’s revenues but they were given 55% of the total company’s debt. SCST is not as good of a business as the rest of YELL and they carry more debt than the parent company so investors are going to have a tendency to sell the shares. Combine this with the small size of the spin-off in relation to the value of YELL (for every $1 of YELL held the day before the spin-off shareholders currently have $0.92 of YELL and $0.11 of SCST), the overhang of shares from indexers (YELL is a member of the S&P 600), and the small market cap that will likely force some funds to sell indiscriminately and it looks like good conditions for an inefficiently priced spin-off.

A few comparisons:

EV/EBITDA P/E P/B EV/Sales
ROAD: 6.73x 29.9x 2.0x 0.33x
ABFS: 14.5x 22.5x 2.1x 0.57x
JBHT: 5.01x 19.5x 1.6x 0.55x
SWFT: 6.11x 30.8x 1.7x 0.74x
USFC: 6.03x 46.2x 1.3x 0.40x

SCST: 3.13x 13.3x 0.7x 0.29x

ROAD, USFC, and ABFS would be the best comparisons because all are LTL carriers, with USFC being an especially good comparison to due the fact that like SCST it is a regional LTL carrier. Thus, SCST is trading at a large discount to similar companies in a variety of metrics and there is no fundamental reason for a discount this large.

D&A is historically well above maintenance CapEx. The company says that the level of CapEx in ’01 and ’02, about $20-$25million in each year, is representative of the maintenance requirement. This compares to D&A of about $45million.

But the most interesting point with this idea is that with the demise of Consolidated Freightways the remaining LTL carriers are expected to benefit greatly. YELL, ROAD, and ABFS are major LTL carriers and all three have seen their stocks rally significantly since Consolidated’s announcement. YELL has gone from $18 to $27(adjusted for the spin-off), ROAD has gone from $24 to $36, and ABFS has rallied from $20 to $30; 50% gains for each in a span of only about a month and a half. Consolidated was generally known to have the most competitive pricing and their removal bodes well for pricing in the entire industry. Most analysts expect LTL carriers to be able to raise prices and increase yields over the next couple of years.

And increasing competition as a result of higher prices won’t happen immediately due to the nature of the business. Truckload (TL) carriers simply carry cargo between two points. All that you need to start a TL business is a truck and a driver. However, LTL carriers haul cargo from multiple customers and distribute it around the country using a hub system. The big carriers are at an inherent advantage because a large distribution network makes it possible to be more flexible and thus be more attractive to customers. As a result it would take a significant amount of capital to start a successful LTL carrier and at the least this will provide time for the current LTL carriers to reap the benefits of reduced competition. Freight rates have been increasing and LTL carriers should see improved results over the next couple of years even if the economy doesn’t rebound in that time frame.

(For example, ROAD announced their results about 3 weeks ago and stated that they saw tonnage increase 17% immediately following Consolidated’s shutdown and are expecting 4th quarter revenues to be up 25-30%. Because SCST is a regional carrier and did not compete as directly against Consolidated it is likely that it will not benefit to the same extent as ROAD or YELL but they will assuredly see some new business and some pricing improvement.)

With SCST you have a business that is trading at an unwarranted discount to competitors and would be a good buy on this basis alone. But there is also an industry-wide phenomenon that will result in improved results for all LTL carriers and this makes it seem even cheaper and serves as a near-term catalyst. A fair target would be 5x EBITDA which would put the stock up around $15-$16.

Catalyst

Improved results in Q4 and beyond due to the removal of Consolidated from the competitive landscape will likely be the near-term catalyst to get the shares up in line with the multiples of similar companies.