Description

UTIW is a logistics company undergoing an operational turnaround that will results in meaningful value creation for shareholders.  The Company is nine months from completing a major systems integration project that should lead to a doubling of earnings and free cash flow.  Today it has a $1.8 billion market value and $2 billion enterprise value.  This turnaround possesses many of the classic signs we look for as improving the chances of success. Specifically, we find in UTIW a relatively new management team of outsiders with relevant prior experience who are executing an operational restructuring from a known playbook to raise the Company’s below peer average margins.   We believe earnings improvement, combined with an improved approach to capital allocation, generates a price target 75% above the current quote.

UTIW is an asset-light logistics company focused on air and sea freight-forwarding and contract logistics.  The Company uses its scale to purchase transportation capacity and re-sells it to customers, capturing a spread in the process.  In addition, the Company leverages its global network to take over the logistics function for customers as well, becoming a vital part of their supply chain. 

A roll-up that was never fully integrated, UTIW has four different freight-forwarding information systems that do not communicate with each other.  This creates a significant overhead and efficiency burden.   By way of illustration, a package sent today from Shanghai first gets inputted into the local system in China.  Once the package arrives in Los Angeles, it is then re-entered a second time into the US system.  Clearly, this duplicative process requires extra time and people.  Moreover, given the lack of coordination between the systems, UTIW requires additional personnel who further check for input errors between the different systems.  So extremely inefficient is the process that UTIW has four operations employees for every one at a freight forwarding competitor.  Moving to one freight forwarding system will obviously lead to huge headcount reductions.  In addition, it will create opportunities for better customer service and greater pricing flexibility. 

UTIW is also rolling out one finance system across the Company to replace a multitude of financial systems that have been strung together over the years, in some cases by manual spreadsheet.  UTIW believes it will be able to reduce its 1,200 finance headcount by 50% once the new financial system is in place.

We are well aware that information systems implementations are inherently risky and usually take longer than expected.  Elements of UTIW’s transformation, however, provide some reassurance and make us more optimistic than many investors.  Specifically, we are comforted by company leadership and the incremental approach to the transformation.  CEO Eric Kirchner has overseen major freight-forwarding systems integrations twice, first during the merger of Menlo and Emery and later after UPS purchased Fritz.  Eric joined UTi in 2009, and has carefully and deliberately led the systems integration project.  Today, the new system is being used to handle 10-15% of all transactions and has been rolled out in 15 countries.  By the end of this quarter, the system will handle 25% of all transactions, will reach 70% of all transactions by the end of this year, and will be fully operational by next spring. 

As we think about the system roll-out, we find a helpful analogy in the construction of a skyscraper in the middle of a busy block.  One has to complete the construction of the skyscraper before moving people in from the surrounding buildings. Similarly, the major headcount reductions for UTIW will not occur until the majority of the system is running successfully.  At that point, UTIW can remove most of the redundant staff.    Today, normalized operating profit for the company is $150 million.  Eliminating 20% of the $900 million spent on personnel would more than double earnings.  The Company has committed to achieving cost savings of $75-$95 million and reaching 12-13% operating margins on a run-rate basis by Q4 of 2014 in comparison with 8%-9% in 2011 and 2012 and 5% in 2013.  This compares to average operating margins at peers of 16% and 29% at industry leader Expeditors. 

We are also enthusiastic about the major change in the approach to capital that the CFO Rick Rodick has brought to the Company since joining in October 2012.  The prior CFO was a hold-over from the old regime, and was retained to ensure a smooth transition for Eric.  Once that was complete, the management and Board recognized it was time to upgrade the CFO function.  Rick has brought a keen focus on cash flow, identifying $275 million of working capital that can be removed from the business.  Indeed, $100 million of working capital has already been taken out.  He plans to remove the additional $175 million, which is close to 10% of the company’s market value, by early 2014.  By next calendar year, the company believes that, going forward, net income will equal free cash flow. 

In addition, Rick has educated the board on the benefits of buying back stock.  While the Company has not yet committed to a buyback plan, our discussions with relevant constituents and management’s recent comments, suggest that a buyback will be implemented by the end of this year.  If a 10% buyback of the shares is combined with our forecasted earnings improvement, the Company should earn over $1.50/share in calendar year 2015. 

While global trade has slowed post the financial crisis, trade growth still remains a secularly growing trend, which favors UTIW and the other freight-forwarders.  In the past, the market has rewarded freight-forwarders with valuations over 20x earnings (Expeditors trades at 23x and has traded at significantly higher multiples in the past) due to the long term growth opportunities and to the high returns on capital (the latter, a reflection of the asset light nature of their operations).  As the turnaround at UTIW becomes clearer, we expect shares to rerate closer to peer valuations, offering substantial upside. 

Catalyst