Description

Who wants to invest in a recession proof business with a 9% yield, capital gain potential, and dividend increases extremely likely? Student Transportation of America is the fifth largest school bus transportation provider in the U.S.; it also has operations in Canada. With only 85% of its 2006’s estimated distributable cash flow and 81% for 2007, STB has the opportunity to substantially raise its distribution. Add in a potential acquisition and STB can easily pay a 10% yield within a year. With such a stable, predictable business with good growth prospects, there is simply no reason for this company to have such a high yield. With C$1.17 a year payout likely within a year, attaching an 8% yield, gets you C$15; a 7% yield gets you C$17 a share. I think that within 12 months, this stock will creep up to C$16 a share. With its 9% yield, STB should provide you with a relatively easy 40% return over the next 12 months.

Company Description:

Student Transportation of America (STB is the ticker, it’s a unit trust on the TSE) is the fifth largest provider of school bus transportation services in the United States, currently operating in 11 states with close to 3,000 buses. STB’s primary service is the transporting of students to and from school, including special education transportation. Additionally, 10% of revenue is generated from extracurricular transportation, charter services and other non-school related charter services.

Approximately 90% of revenues are contracted with an average term of three years. STB has successfully acquired and integrated 18 school bus contractors. It has also won 22 new school districts through bid processes and completed six school district conversions (from public to private provision of school bus services) since its inception in 1997. STB has grown by a compound annual growth rate of 23% in the last five years. The average life of STB’s buses is 5.5 years.

STB’s focus is on rural and suburban markets due to the lower cost of operations, increased safety, improved contract stability and retention and a decrease of competition.

STB’s Strategy & Growth Opportunity

STB’s strategy is the creation of regional density through what STB calls its “ABC” strategy. ABC is acquisition, bid and conversion. STB has acquired mom and pop buses, bid on bus management awards and converted government run busing programs to STB run (conversions involve no capital as the schools own the buses, STB just runs the school buses). STB has completed twenty acquisitions, 25 bid awards and 3 three conversions since inception.

The school bus transportation industry generates approximately $13 billion in annual revenues. There are significant opportunities to consolidate as 5% of the market is served by an estimated 4,000 private companies. Acquisitions are acquired at 3.5 to 5.5 times EBITDA, which makes them instantly accretive to a company that is trading at seven times forward EBITDA. (None of the cash flow estimates include any acquisitions, despite the fact that they should do at least two in the next twelve months.)

Also, there are attractive trends such as the fact that public schools continue to convert schools to private providers, as well as there are an increasing number of students being identified as requiring special transportation needs. Overall, enrollment in U.S. schools is growing at a rate of 5%.

Since going public, 55% of its revenue growth has been acquired, versus 45% organic growth.

Compelling internal business stats

STB has many compelling aspects:

1) Low cost of capital of just 7%.
2) In its operating history of 217 renewable contracts, 207 have renewed
3) Not one contract is more than 5% of revenue
4) Most contracts average between $500K to $4 million.
5) The average contract time frame is 3.8 years, with renewal features
6) Despite insurance and fuel costs substantially increasing the last five years, EBITDA margin has been steady at 19%.
7) STB’s work force is not unionized, 70% are women and 50% are retirees
8) STB’s margins have been very stable for five years at 19%

Gas prices a risk? What about other costs?

STB’s cost structure breaks down as follows:
-Labour & benefits – 53%
-depreciation -15%
-SGDA – 11%
-maintenance – 6%
-fuel – 6.5% (in 30 years 4-7%)
-insurance – 5%
-other – 3.5%

Fuel is only 6.5% of its cost structure. This should allay any fear of what the spike in gas prices has done to STB. Also, 45% of contracts pass thru or fuel escalation and this number is increasing, so that by 2006, fuel escalation clauses should be in more than half of all contracts.

Also, escalating fuel costs may be a big positive on the acquisition front. Smaller players have to be getting squeezed and may opt to sell out to STB more readily. STB due to size and scale is able to spread its fuel costs over a bigger base. And due to its size, it can save money on large volume purchases. STB may also be able to better negotiate with school boards for fuel escalation clauses.

The best argument to how well STB is managed and how fuel and insurance are not too big of a risk are its stable 19% margins for the past five years.


IPS explanation

STB has a unique unit structure called an IPS. Here is from STB’s website (http://sta-ips.com/build/index.php):

“Each Income Participating Security (IPS) of Student Transportation of America Ltd.represents one common share of STB and C$3.847 principal amount of 14% subordinated notes of Student Transportation of America ULC (STA ULC). STB and STA ULC together hold all of the issued and outstanding Class A common shares and preferred shares of Student Transportation of America Holdings, Inc. (STA Holdings), representing an 85.1% interest in STA Holdings. STA Holdings owns all of the issued and outstanding common shares of Student Transportation of America, Inc.
The subordinated notes will have a term of 12 years. On or after the fifth anniversary of the closing of the initial public offering, STA ULC will have the option to redeem the subordinated notes in whole or in part at any time, for cash, at a redemption price equal to a premium over the principal amount of the notes, which decreases over time.
Each cash distribution to IPS holders consists of a cash dividend from the common shares and an interest payment on the notes.”
Estimates and Valuation

I estimate that STB will earn close to $25 million in EBITDA (June 30th fiscal year end) and have distributable cash flow of C$1.30 a unit. Assuming a 90% payout ratio, STB’s distributions will be C$1.17, meaning that STB trades at a 10% yield of my forward estimate.

With an acquisition or two, STB’s number could be $27 million in EBITDA and $1.30 in distributable cash flow per unit. That would indicate an 11% yield.

I estimate that as STB performs and executes, investors will be attracted to its safety, recession-resistant profile and stable cash flows. At a 7.5% yield of my conservative estimate, STB would be worth C$15.6 a share that would be 30% return. Add in the dividend, and investors would see a 40% total return.

Under my a slightly more aggressive scenario, adding in an acquisition or two, STB at a 7.5% yield would be worth $17.3 a share, indicating a 55% return. I believe the risk/reward with this investment is fantastic.

Summary

STB represents an excellent risk/reward situation in which you can invest in a stable, recession-proof company that has an extremely high yield given current interest rates and offers very good capital gain appreciation. The only reason, it is not higher right now is due to its recent IPO of last year and overblown concerns about fuel prices. I look for a 40% to 55% return over the next twelve months.

Catalyst

1)Increased distribution
2)New acquisitions and bids that will increase earnings
3)Recognition of the recession-resistant nature of the business