Description

May 14th, 2014

Universal Truckload Services is an attractive Magic Formula-esque equity with ~40% upside to current price. While the fundamentals of the equity are underappreciated by the market, what is really interesting is the structural selling that has apparently driven the company to its current bargain price. We believe that the large recent secondary public offering process has put undue pressure on the stock, allowing investors to step in as liquidity providers to buy a good business with solid industry and growth prospects at well-below-average risk. Additional reasons for misvaluation include messy financials as a result of a significant recent acquisition, small market cap and small float (27% of CSO) and minimal/very inadequate sell-side coverage.

UACL is an asset-light 3PL service provider. The company offers transportation services (63% of revenue) through its network of owner-operators and third-party transportation providers. These services include typical commodity transportation as well as full service international freight forwarding, customs house brokerage services, and final mile and ground expedite services. Additionally, the company offers “value-added” services (25% of revenues), which are essentially customer-specific supply chain solutions (sequencing, sub-assembly, cross-dock services, etc.). Finally, UACL provides intermodal services (12% of revenues).

 UACL entered the value-added supply chain management business through its acquisition of LINC in October 2012. This business is (1) a higher margin business than the traditional trucking business (mid-teens versus low-to-mid single digits), (2) contract-based versus transactional for traditional trucking (often 3-5 years to match customer’s production cycles), (3) “sticky” -- many of the logistic facilities are directly integrated into the customer’s supply chain, and (4) slightly more capital-intensive than traditional trucking, but most facilities are either provided by the customer or leased to match the duration of the contract. UACL believes that numerous cross-selling opportunities exist with the combination of these offerings. Management is looking to make accretive acquisitions in this fragmented industry -- this past December, UACL acquired Westport for $123 MM, a value-added provider of warehousing and component distribution services.

It is important to attempt to understand the Moroun family, mainly Manuel (86) and his son Matthew (40), when trying to understand the UACL story. As quoted in Forbes:

"Strength in the auto industry has helped trucking and logistics magnate Manuel "Matty" Moroun, who with his son Matthew owns Universal Truckload, P.A.M Transport and other trucking interests. Matty also controls Detroit's Ambassador Bridge, the busiest border crossing between the U.S. and Canada. He recently got environmental clearance for a second bridge. But Canada and Michigan hope to build a public bridge instead. The two sides continue to fight in court." http://www.forbes.com/profile/manuel-moroun/

However, this article is the one to read to understand these somewhat ecentric billionaires: <http://www.businessweek.com/articles/2012-05-03/matty-moroun-detroits-border-baron#p1> Cliff notes version: they are in a legal and political battle with Detroit, Michigan and Canada over the status of their prized possession: The Ambassador Bridge into Canada. It is the only privately owned border crossing, has very high traffic, the Morouns run it like a monopoly and nobody else likes it.

To summarize the family holdings:

CenTra - The holding company for the Ambassador Bridge and Central Transport International, a trucking and shipping company. The bridge is by far the family's most valuable asset, with estimates of it being worth between $1.5B and $3.0B alone. Side note, Munger and Buffett held a stake in this bridge that they ultimately sold to Manuel in 1979. Central Transport is privately owned by the family and is the owner and operator of a large fleet of tractor trailers.

Universal Truckload Services - The Morouns control this company with 72% of the CSO, currently worth $490MM.

P.A.M. Transport - Another trucking and transportation services company, publicly traded as PTSI with a market cap of $190MM. Matthew Moroun owns 59% of the CSO as of April 29, 2014, making his stake worth $112.

It is difficult to understand the full motivations and plans of this family, but a few things can be gleaned from public information. 1) The family is being villainized in a highly political battle over the Ambassador Bridge. Manuel Moroun was tossed into jail for a while. Michigan and Canada want to build another publicly owned bridge that would really hit Ambassador traffic, and Manuel wants the Moroun family to build the second bridge. This is not a cheap fight, and it seems like the family is burning through cash with all of the legal, real estate and building work that they have been doing lately. 2) Despite being quite illiquid, UACL is actually the family's largest liquid asset. It is a public vehicle that allows them to cash out some of their funds. 3) The family owns 72% of UACL and only 59% of PTSI. It seems like the family will ultimately try to trim their stake, as a controlling stake above 55% is capital that is locked up and undiversified. These three things could explain why the family may be seeking liquidity in its UACL position.

In October 2012, UACL completed the acquisition of LINC, which was really a Moroun family merger. The Morouns owned 100% of privately-held LINC and a controlling stake in UACL. The transaction occurred at 6.5x LTM EBITDA in a stock issuance and assumption of LINC debt. The Morouns ended up with an 82% ownership of (new) UACL. Management was/is well aware of the valuation penalty imposed because of this control factor and limited float; as such, in March 2013 they filed a mixed shelf registration that allowed them to raise $350MM in capital and covered the sale of up to 6.5MM shares held by the Morouns (out of then-total share ownership of 24.5MM).

Subsequently, UACL and the Morouns have completed two secondary offerings. The first, in August 2013, saw the Morouns sell 0.975MM shares at a public offer price of $23 / share. The second, in late April 2014, saw the Morouns sell 1.880MM shares at a public offer price of $26 / share (in both offerings, UACL also sold a small amount of stock, but this was to cover offering expenses -- the company did not receive any remaining proceeds from the sale).

The most recent offering appears to have put an inordinate amount of pressure on the stock price. On Friday, 4/25 (last trading day before offering commenced), the stock last traded at $27.88. On Monday, 4/28, the stock closed down to $26.81. The bulk of the offering took place on Tuesday, 4/29, after the pricing was announced pre-market at $26. The stock opened 4/29 around $25; we believe that the order was simply too much for the market to swallow and, consequently, the offering had to be extended beyond the May 2nd target end-date (note significant volume and downward price pressure on May 6th and 7th). As of this writing, the stock is around $23, down 17% from its pre-offering price.

To put in perspective the amount of pressure caused by this offering: before the offering, the Morouns owned ~23.5MM shares out of total shares outstanding of ~30.1MM, meaning a float of ~6.6MM shares. Attempting to complete a secondary offering of 1.88MM shares represents 28.5% of the then-outstanding float (alternatively, represents 22% of the “new”  float of 8.48MM). This moved the volume of trading up to 975K on 4/29 in contrast to an average volume of 85K shares per day.

Why did the August secondary proceed without a hiccup? For one, the offering did not make up as large of a percentage of the then-outstanding float. Before the offering, the Morouns owned ~24.5MM shares out of total shares outstanding of ~30.05MM, meaning a float of ~ 5.55MM shares. Attempting to complete a secondary offering of 0.975MM shares represents 17.5% of the then-outstanding float (or ~15% of “new” float). So, while still a sizable sale, not quite the scale of the April offering. Additionally, the pre-offering price of the August sale was $25.40 (last quoted price of last trading day before offering commenced). With the secondary offer priced at $23, this allowed for more margin of error compared to the $27.88 pre-offer and $26 offer of the April secondary (and, with the substantially larger size of the offering, one would think they would have been even more conservative with the offer pricing). Finally, the underwriters of the August secondary (Citi) were allowed the purchase of an additional 0.150MM shares from the selling stockholder (Morouns), representing ~15% of the total offering. The underwriters of the April secondary (MS), were only allowed 0.190MM, or ~9.5% of the total offering. Therefore, it is likely that MS was unable to prop the stock as effectively.

We have been looking for other possible reasons for the sharp tradeoffs, but cannot find a fundamental reason for such a decline. The company announced Q1 2014 results on 4/24, and despite a lousy quarter beat consensus estimates. The stock was stable after the announcement and after the earnings call. Peers also show little correlation to UACL in terms of trading price, so we are confident that we aren't missing a large industry trend.

For background on the asset-light 3PL business model, we refer you to amr504’s 2002 write-up on Landstar <http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/499> LSTR’s business, while now on a greater scale, mirrors UACL’s trucking business.

Salvo880 also did a 2012 pitch on another 3PL provider, XPO, which has solid background on the pros and cons of the industry <http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/81850> We think that a lot of strong points were made by many users in the message-chain bloodbath on both sides of the story, and we will try to add our take on things without repeating others.

We believe that this is an above average industry, driven in large part by favorable trends toward increased complexity and increased outsourcing of supply chains. We think that there are clear benefits to both scale and scope, even if just within a particular industry or geography. This is because fixed overhead and IT costs can be spread over a larger revenue base, and because there are network effects in this business. In many cases, there is customer captivity, as supply chains and relationships become integrated within client companies’ operations.

There is concern that scale and scope could evaporate as brokers or agent networks simply leave a company, making acquisitions silly because they are “intangible”. We do not believe that this is the case, as both the acquired broker and the parent company benefit from increased scale and network post-acquisition. Since agents and brokers are paid as a percent of revenue, an increased network leading to higher revenue generation potential within a larger company benefits them as well.

Within the larger 3PL space, it seems to us that the asset-light and value-added businesses are the most desirable. The asset-light business provides the most flexibility in down-cycles and with customer solutions, and obviously allows for higher returns on capital in growth situations. However, in up-cycles asset-light businesses miss out on some juice as fixed asset capacity in the market becomes tighter. Traditional business models such as transportation and truck brokerage have become more competitive recently driving down returns and margins, while the value-added service business has higher complexity, driving more customer captivity and higher returns.

Below is a helpful visual that lays out where the various logistics companies focus their service offerings. This graphic was also helpful in selecting comparable companies for the valuation analysis:

As the chart above shows, the current UACL is a diversified 3PL provider, even more so with the recent Westport acquisition. The company is an asset-light provider, though it is important to note that the company does own 18% of the tractors and 50% of the trailers that it uses to provide its services. This asset ownership provides a hedge against tight capacity, and management has noted that in the current upcycle it may actually acquire more tractors to mitigate tightening. We are not worried that this reflects a wider shift away from the asset-light business, however, as management is constantly touting the merits of the non-asset 3PL model.

We feel that the diversified business model bodes well for the company, and will provide additional flexibility to grow. The diversified model also appears to be the preferred model in more mature 3PL markets like Europe, where clients get the benefits of a one-stop-shop for supply chain, and companies see numerous opportunities for cross-selling. The legacy transportation services business is less attractive in the current market, but the value-added business is growing at a fast pace. Management has emphasized its dedication to growing the VAS business both organically and through acquisition.

In terms of scope and scale, we find that most 3PL providers have both industries and geographies of expertise which effectively act as “hubs”. While they operate throughout the U.S. and to a lesser extent Mexico and Canada, for better or worse, UACL’s hub appears to be centered in the upper midwest and southeast, where it has a strong hold on automotive and other heavy industry. Management is actively seeking to diversify into other industry verticals. We are not confident that they will be super successful in diversifying away from their hub, but also feel that providing heavy industry logistics can be a good business offering solid competitive advantages.

As far as management of UACL is concerned, we think that they are strong, but nothing to write home about. They are incentivized well and watched over by the Morouns, who truly run the company as owners. Pay is certainly not extravagant, with all of the executive officers paid < $1MM in 2013. After the LINC merger/acquisition, the previous CEO of Universal stepped aside to become President, and the LINC CEO and CFO stayed in their roles at the consolidated company. It seems that this transition has been smooth.

The current value disconnect is pretty apparent at first glance. This company has low fixed costs and low maintenance capex, high returns on capital, and solid growth. 12.7x historical PF earnings is a bargain. The company is trading at 5.6% UFCF, but we feel that under normalized working capital and capex situations, this number would have been well above 7%, with a LFCF above 9%.

In order to quantify a target valuation, we decided to use comp valuation. It is important to note, however, that there are no standout comps for Universal due to its recent acquisition of LINC; the new Universal represents a unique 3PL that offers a suite of services across traditional transport, supply chain management and intermodal.  Our Core Comps were chosen based on their similarity with legacy Universal -- a traditional, asset-light trucking business. These include Landstar, C.H. Robinson, and Echo. Even though Universal is diversifying away from this line of business, it still represents the bulk of its operating revenue (63% for PF 2013). We also looked at a set of ancillary comps. These companies are notable in that they, too, have asset-light 3PL service offerings; however, they derive the bulk of their revenue from more specialized services. For example, Hub Group is primarily focused on intermodal; Forward Air on freight forwarding; and Expeditors International on expedited shipping.

The main reason:

• Massive amount of structural selling. As discussed extensively above, the owners are seeking liquidity and have dumped over 25% of the float into the market over the past 20 days.

• Many people are overlooking the accounting for their recent acquisition. PF cash flow metrics are understated in the 2013 10-K (since the acquisition took place in mid-December), while the balance sheet incorporates the additional debt.

• Small size (Mkt. cap < 700 MM) with only 27% float makes the maximum opportunity size quite small.

• Only 4 sell-side analysts “follow” this stock. All of the analysis is subpar.

Short-term risk: the Morouns dump even more stock onto the market - This would actually provide even more compelling opportunities to buy, but investors should be aware that more structural selling could drive the stock down further and leave capacity to purchase more in the event that this occurs.

Catalyst

Selling pressure from Moroun share sales stops. This stock is quite optically cheap. A cessation of downward selling pressure should lead to a prompt correction.

Overall increased liquidity draws a larger following. Further liquidity should put more eyeballs on this stock.