Description

I am short the less-than-truckload industry on the view that it is at an unsustainable cyclical peak where consensus estimates and valuations are assuming we have reached a sustainable “new normal” in industry profitability.  I am recommending short SAIA.  

I will avoid a detailed write-up on the industry background other than to point you to the public materials for the large LTLs (SAIA, ODFL, ARCB are good starting points).  At a high level, LTLs are the highest-cost mode of transporting goods (on a $/ton-mile basis) and therefore typically serve smaller loads (less than a full truckload) and operate on a “milk run” type of routing which brings high fixed costs.  On average, ~40% of volume goes to general retail and ~60% to industrial/manufacturing (supply chain).  The artificial boom in goods consumption from the massive covid-related stimulus was incredibly beneficial to the industry as truckload capacity became extremely tight and excess price-inelastic demand spilled into the LTL networks, leading to significant price increases and margin expansion given the inherent operating leverage in the businesses.  In addition, the LTL industry net benefits from fuel surcharge increases (b/c it is impossible for customers to discern how much fuel they are using for a comingled shipment, and typically these increases go up during economic booms in shipments).  The cycle is currently rolling in the other direction, with TL demand and rates back to pre-covid levels.  LTL always lags by ~6 months historically, however we do not believe this is priced into the stocks currently.   

Historically (2016-2019 pre-covid), SAIA earned ~$4/share in EPS on a 7-8% operating margin.  This year, consensus expects $14/share in EPS on an 18% operating margin.  The stock is trading at 17.5x P/E on that number, consistent with the 15-20x EPS pre-COVID with an average around 18x.  I model earnings reverting back to $8.75-$9.00 in ’23 on margin normalization (to 12.5%) and normalized fright rates.  SAIA is currently trading at 27x my normalized EPS. Assuming the multiple corrects to the historical average of 18x on 2023 trough EPS estimate of $8.80, I can get to -33% downside to ~$160. 

The biggest swing variable that would take our EPS estimates higher / lower is pricing. The ultimate driver of pricing will be US Manufacturing PMI, which is the leading indicator for SAIA’s multiple and earnings (close relationship historically), as 60% of SAIA’s volumes are levered to industrial end markets. 

Thesis:

SAIA is overearning from strong goods demand. 

• Tight supply and demand enabled LTLs to push pricing and improve mix, and was aided by some spillover of heavier shipments from the TL market into LTL. LTL shipments and pricing growing at significantly elevated levels vs. history (+mid-teens 2022 YTD vs. historically ~2% volume and ~3-5% price).  

• TL spot rates are now rolling over, retail inventories are too high and retail demand is falling, which will likely lead to TL volumes coming out of the LTL networks, hurting mix over the next few quarters

• Through 2022 and in 2023, there is increasing risk of a U.S. recession or at least PMIs falling below 50 into contractionary territory. This would cause LTL volumes to decline and in my view, cause pricing to decline by ~LSD depending on the magnitude of volume declines.  

Valuation:

10-yr historical average P/E of 18.5x with pre-COVID range (2012-2019) of ~15-20x. 

Risks:

• Potential for price discipline to insulate EPS declines. Given incremental margins are 20-25%, it would take 4-5% volume growth to offset a 1% decline in pricing, so LTLs are incentivized in a poor macro to hold price instead of chasing volume. Pricing has held up positively in LTL cycles over the last decade, but pricing increased by so much in the last two years (+9% in 2021 and +10% in 2022E) that I think it is likely to decline this time. 

• Strong historical track record of EPS growth. SAIA’s price / cost spread only turned negative once over the last decade (2016) when PMI fell to 50 and EPS declined 11% yoy. Price increases have enabled margin expansion through the cycle. Bull case on SAIA is they can close the OR gap vs. ODFL by pushing price (currently priced at a 25% discount), however, while narrowing a bit over the last few years, this discount has been relatively constant over time. 

Catalyst

Cycle rolling over