Heartland Express Has Tools To Offset A Cyclical Trucking Correction

Times are starting to get tough in the trucking industry. High channel inventories and weakening end-user demand are undermining the demand side of the equation and there is now significantly more capacity in the market. With that, spot rates are falling and are likely to collide with (and then briefly go below) spot rates in 2023, or possibly sooner.

That’s not a great set-up for any trucking company, but Heartland Express (NASDAQ:HTLD) is more than just any trucking company. Heartland has a strong operating track record and a solid core of drivers and equipment that stand out in the industry, not to mention long-standing customer relationship. The company also has M&A synergy levers to pull in 2023 that I believe can help offset some of the sector pressures coming in 2023.

Heartland shares have slipped about 4% since my last update, outperforming Knight-Swift (KNX) and Werner (WERN) by about 5%, as well as outperforming the broader transportation sector (the DJT is down about 16% over that time). I don’t prefer Heartland to Knight-Swift, which I recently wrote about here, but I do see Heartland as undervalued and possessing some counter-cyclical attributes that could help over the next six to 12 months.

 

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Heartland Express Has Tools To Offset A Cyclical Trucking Correction

Heartland Express Continues To Muddle Through As Trucking Rates Approach A Cyclical Top

The going hasn’t gotten any easier for Heartland Express (NASDAQ:HTLD) in the last couple of quarters, as the company has continued to miss revenue expectations and has run its streak to five straight quarters of weaker than expected top-line results. While earnings performance has been a little better relative to expectations on a reported basis, gains on equipment sales have been an important part of that performance and seem unlikely to continue at the same rate. On top of all that, truckload rates are likely to peak in the first half of 2022 and then start declining.

I wasn’t that positive on Heartland back in August of 2021, and I thought investors would do better with Knight-Swift (KNX). Since then, Heartland shares have fallen about 10% versus the 15% rise in Knight-Swift, while Werner (WERN) and Schneider (SNDR) have likewise outperformed.

Given the underperformance at Heartland and the opportunity to take advantage of better driver availability, I think Heartland is likely less vulnerable to this next phase of the cycle and may well show better counter-cyclical performance. That said, I still think Knight-Swift offers a better long-term opportunity.

 

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Heartland Express Continues To Muddle Through As Trucking Rates Approach A Cyclical Top

Driver Shortages Hitting Heartland Express Where It Hurts

 

While these are boom times for truckers from an available volume and pricing strength standpoint, actually taking advantage of the boom is a different matter. Driver shortages are a challenge across the industry, and it has led to actual year-over-year declines in revenue for Heartland Express (HTLD) as it can’t operate its fleet at full capacity. On top of that, there are growing concerns that 2022 will be the peak year for the cycle, leading investors to leave the sector for greener pastures.

These shares are down about 10% since my last update, underperforming rival truckload carrier Knight-Swift (KNX) and the Dow Jones Transports by a wide margin (around 35% and 27%, respectively). Although I do think that the market may be already pricing in a conservative outlook for the trucking industry, and these shares are close to a 52-week low, if I were going to take the risk of entering the sector now, I think I’d rather own Knight-Swift.

 

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Driver Shortages Hitting Heartland Express Where It Hurts

Strong Freight Demand Not Helping Heartland Express's Share Price

While the economic recovery in the U.S. is driving healthy demand growth for freight, it’s not benefiting truckload haulers all that much. It’s not uncommon for these stocks to underperform even as spot rates rise (largely a “sell the news” phenomenon that is driven by fears of capacity and expense growth), but I’ve still been surprised with the underperformance over the last few months even in the face of improving demand indicators.

I said that Heartland Express (HTLD) wasn’t my favorite trucking stock when I last wrote about it in October, and the performance has been lackluster. Knight-Swift (KNX) and Werner (WERN) really have done no better, though, and even the mighty and much-loved Old Dominion (ODFL) (a less-than-truckload carrier, which is a different business) has lagged the S&P 500.

I do believe that Street expectations for truckload pricing power may be too low, and I also think there is evidence of progress on margins at Heartland. These shares do look more than 10% undervalued on an EBITDA basis (using a long-term average multiple), and the P/E multiple is well below the historical norm relative to the S&P. That makes this an increasingly interesting name to me; I don’t necessarily love Heartland or its business model, but I do have a soft spot for overlooked stories and I’m starting to think this might be one.

 

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Strong Freight Demand Not Helping Heartland Express's Share Price

Truckload Could Have Some Upside, But Heartland Express Is Harder To Love As The Play On It

Although transports aren't a bad way to play economic recoveries, the stocks of truckload trucking companies can be frustrating if you're not familiar with them. Stocks often trade up in anticipation of higher rates, then sell off when those rates actually materialize. To that end, spot truckload rates are about 30% higher than a year ago (and were recently up 40%), but Knight-Swift (KNX), Werner (WERN), and Heartland (HTLD) are all 10% to 20% off of recent peaks, even though contracting pricing should improve by double digits relatively early in 2021.

I do think that the truckload sector is likely undervalued today and offers a pretty good upside/downside trade-off, but I'm not sure Heartland is the best play on that opportunity relative to Knight-Swift and Werner. Heartland had a good long-term track record where profitability is concerned, but margins have been falling for over 15 years on a core basis and are now pretty close to Knight-Swift's and Werner's. Heartland also paid a high price to build a national footprint and has yet to really successfully leverage that footprint.

The bull/bear debate basically comes down to this - Knight-Swift and Werner likely offer "safer" upside, but if pricing really firms up next year and Heartland has finally found the right combination to unlock the potential of its footprint, there's more upside here. This is not a well-liked stock, though, and the long-term differences in stock returns between Heartland, Knight-Swift, and Werner aren't just a fluke.

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Truckload Could Have Some Upside, But Heartland Express Is Harder To Love As The Play On It

Knight Transportation's Leverage To A Trucking Recovery Amply Reflected In The Shares

It stands to reason that a company that is much more leveraged to trucking spot prices would outperform its peers when those spot prices start to show improvement. It also doesn't hurt when you're an above-average operator in terms of efficiency and margins. Knight Transportation (NYSE:KNX) wears both of those crowns, and the shares have been quite strong in what had been a challenging year for the truckload carrier market prior to the late fall.

There's a lot to like about Knight, as the company challenges Heartland (NASDAQ:HTLD) for the top spot in "clean" operating ratios and it has a long and strong track record of return on invested capital. What's more, the company's diversified customer base and spot rate exposure should serve it very well if/when capacity starts tightening up. The "but" is valuation; Knight's strong metrics and leverage to a recovering trucking market may argue for a premium, but 10x 2017 EBITDA is too rich for my blood at this point.

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Knight Transportation's Leverage To A Trucking Recovery Amply Reflected In The Shares

Heartland Express Has Some Blockages When It Comes To Growth

As problems go, Heartland Express's (NASDAQ:HTLD) collection of challenges could certainly be worse. Long one of the best-run truckload operators out there, Heartland runs an exceptionally tight ship. This company's history of tight cost control, relentless efficiency, and high standards for driver performance has led to excellent operating ratios, good asset turnover, and strong operational metrics, which have in turn translated into good cash flows and excellent returns on capital.

The problem for shareholders, though, is that this already-excellent company doesn't have a lot of levers to pull to do meaningfully better. An improving trucking market will certainly help, but it likely won't help Heartland as much as other operators and the company still has some distance to go before returning to the sort of margins it generated before the Gordon deal (if that is even possible). Heartland does look reasonably valued on an EBITDA basis, though, and in this market "reasonably valued" is often about the best you can find.

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Heartland Express Has Some Blockages When It Comes To Growth

Investopedia: No Summer Holiday Yet For Rail Traffic

June's rail traffic numbers certainly offer up a mixed message. Investors and economists who believe that the recovery is in a rough patch but still ongoing can find support for their position. Likewise, those who believe that the recovery is gasping for breath (if not toppling over) can find their own "ah ha" moment in the numbers. All in all, it makes for a tough backdrop for rail and transport investors; Wall Street typically hates uncertainty and it would seem to only be a matter of time before their ongoing faith in the rails is sorely tested. 


U.S. Traffic - Some Good, More Bad
On the plus side, U.S. rail traffic did grow 0.9% from last year's June and the number of positive reporting categories (that is, traffic categories with year-on-year growth) expanded from eight in May to 14. That concludes the good news portion of today's article.

On the down side, traffic dropped again on a sequential basis (0.7%). Now, it is not all that unusual for rail traffic to slide sequentially into the summer months. If this year follows the template, traffic should bottom in July and rebound into and through the fall. 



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(Repost) Investopedia: April Rail Data - A Penny On The Tracks?

There is an interesting set-up in the transportation sector right now. The Dow Jones Transports Index is near a 52-week high, but it looks like momentum in the rail sector may be slowing. One month certainly proves nothing, but if traffic volume is stagnating that could mean that the end of robust revenue growth in the industrial sector and a transition to the next phase of the economic cycle.


A Tough April for King Coal
According to Rail Time Indicators, a monthly publication of the Association of American Railroads, U.S. rail traffic slipped 0.2% from the year-ago level in April and 2.5% on a sequential basis - the first year-on-year decline in over twelve months. Intermodal traffic was stronger though, growing 9% annually and 1.2% sequentially. (For more, see Rail Traffic Suggests A Slower Pace.)

At over 40% of all carload traffic, as coal goes, so goes the rail sector and April was a tough month for coal shipments. Coal traffic declined 2.9% from last year, but this number merits a little more investigation. Back in 2010, the April carload figure for coal surged more than 7% as utilities looked to rebuild coal stockpiles that had been run down during the recession. Consequently, it was a very difficult comparison. 

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Investopedia: Old Dominion's Great Growth Story

Old Dominion (Nasdaq:ODFL) seems to be one of the exceptions. Old Dominion has long been a great growth story within a cyclical industry, and this quarter is another example of how not all trucking companies are alike. Although this is not an easy company to value, Old Dominion is gaining share and building a business that is getting increasingly attractive. 

There are some pretty sharp divisions among the transport stocks these days. Railroads have enjoyed a great run and air transport companies have seen a solid pickup in business, while ocean-going carriers have been struggling. With trucking it's a more complicated picture - the volume has been there, but pricing has been soft and many major haulers are struggling.

Solid Start to the Year 

Old Dominion has opened the year with 33% top line growth. Tonnage climbed over 20%, while a modest give-and-take between haul length (up 0.7%) and weight per shipment (down 0.6%). Pricing was rather strong as well; up over 11% as reported, and up more than 6% when stripping out the company's fuel surcharges.

Old Dominion has stood out in the past for its operating efficiency and that was true again this quarter. The company showed operating income growth of 132% and the company's operating ratio improved by nearly four full points from the year-ago level to 91. That stands in significant contrast to major carriers like Arkansas Best (Nasdaq:ABFS) and YRC Worldwide (Nasdaq:YRCW). One of the advantages to the Old Dominion model is its lower labor costs, and that held true this quarter - though these costs climbed nearly 23%, they were about 52% of revenue or more than 10% less than the share of revenue paid out by Arkansas Best. (For related reading, see Bad Times For Arkansas Best.)

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Old Dominion - Sometimes The Best Is Not Good Enough

I am a little late getting this analysis of Old Dominion (Nasdaq: ODFL) up, but I hope it is better late than never. ODFL is a stock I owned (profitably) years ago and still like to follow - I think it is hands down the best less-than-truckload (LTL) carrier out there. Nevertheless, being the best in your business does not necessarily mean the stock is worth buying.

It was a solid second quarter for ODFL. Revenue rose 16.5% to 368M, and handily beat the estimate of $359 million. This revenue was produced by a nice increase in tonnage (up over 13%), offset by a decline in fuel-adjusted pricing (down about 1%). That weak pricing environment is one of the big worries in this space - although ODFL has not matched smaller rivals in taking bad pricing just to keep the trucks running, they have not been able to escape it all together.

Where ODFL really shined this quarter was in its cost control. The company's operating ratio (basically the opposite of operating margin) improved more than 400 bp to 89.1%. Lower non-cash charges (mainly depreciation) helped a lot, but the company also saw quite a bit of improvement by holding down wage growth and compensation costs.

Management was a bit cautious about the second half of this year, and given the economic news that has come out this week that seems reasonable. I am not sure that LTL carriers like Old Dominion are any better "tells" on the economy than truckload carriers like Knight (NYSE: KNX) or Heartland Express (Nasdaq: HTLD), but it stands to reason that LTL would be tied more closely to the tenor of small business (since they cannot afford to send out whole truckloads at a time). Either way, I would not be surprised to see continued pricing weakness this year, though weakness in tonnage would definitely be a bad sign for the economy.

Trying to value Old Dominion and assess its future is pretty tricky. The company has spent most of the last decade building up its business. It takes somewhere around 250 - 300 service centers to operate a national LTL business, and Old Dominion started the year with about 210. So even though ODFL will always have to spend on new equipment (trucks, trailers, etc.), the big build-out is close to an end. That means cash flow leverage.

Also, even though ODFL is a rather efficient operator in the LTL space, they are not the top in all metrics. Rival Con-Way (NYSE: CNW) seems to produce considerably more revenue per service center than ODFL (about 2.5 to 1). Now, ODFL is ahead of the likes of Arkansas Best (Nasdaq: ABFS) and there may be idiosyncrasies with Con-Way that make a straight-up comparison misleading, but it still seems to me that ODFL can (and should) get more leverage out of their infrastructure. If they do that ... more cash flow.

So, all of that being said, I still run into a wall when it comes to evaluating ODFL on a cash flow basis. Even allowing for significant free cash flow leverage (free cash flow margin moving from a historical level of -3% to 6% over five years, with above-trend growth in the five years after that as well), I get a DCF-derived price that is about 10% below today's level. Turning to an alternative methodology, forward EV/EBITDA valuation, I get a target of $45.50 (using a 7x forward multiple). That is certainly better, but still not enough to excite me.

All in all then, Old Dominion is a good company that is priced like one. I might be interested if it pulled back 10-20%, but there is just not enough potential here to get me to buy.