ArcBest Is Cheap, But Asset-Light Results Need To Improve – ArcBest Corporation (NASDAQ:ARCB)

ArcBest (ARCB) is trading at 0.82x book value and its forward P/E ratio 10x. The stock corrected after its recent earnings and its performance over the last 18 months has been very disappointing with the stock down ~50% from the highs it made in late 2018. The company has two reporting segments: Asset-Based (which is primarily its Less than Truckload (“LTL”) business) and Asset-Light (which is primarily third-party logistics business).

For the full year 2019, the company reported $2.1 bn in LTL revenues (down 1.2% on per day basis versus 2018) and its operating profit was $102 mn (versus $103.8 mn in 2018). Slowdown in industrial end market due to tariff concerns impacted volume with tonnage per day declining 4.8% y-o-y, but the pricing in LTL markets remained strong. In the asset-light segment, the company saw a year over year decline of 2.7% in revenues while non-GAAP operating profit declined to 11.2 mn versus 26.5 mn in 2018. The main reason for the decline in operating profit was lower demand for the company’s expedited service, which is a high margin business.

Strategy and the long-term opportunity

ArcBest’s Less than Truckload (“LTL”) business is unionized. While the company has done much better than its other unionized peer YRC Worldwide (YRCW) and management deserves credit for its execution, ArcBest still has a high cost structure. Its operating ratio in the last two years was 95.2% which is much higher than non-unionized peers (Old Dominion (ODFL), SAIA (SAIA), and XPO’s (XPO) LTL businesses have operating ratios of the 80s).

There is not much management can do about its high cost structure due to the unionized workforce. It has tried to incentivize its union workforce by offering a bonus sharing arrangement whenever operating ratio for the full year is less than 96% and this strategy seems to be working. But I don’t see it likely that its operating ratio can ever match non-unionized LTL carriers.

Management realizes this and instead of investing more to grow its asset-based LTL business, it is focused on growing its asset-light third-party logistics (3PL) business which is non-unionized. The company acquired Panther Expedited Services in 2012 to pursue this strategy and has grown its asset-light revenues from $571 mn in 2013 to $950 mn in 2019.

The strategy has two benefits. First, the company can cross sell its logistics services to existing asset-based (“LTL”) customers and generate incremental revenues. Second, it can direct some of its 3PL (third-party logistics) volume to its asset-based business and improve utilization. This comes handy during a slowdown when instead of using third-party transportation providers, the company can use its own spare capacity. It makes asset-based business less cyclical.

In the long term, management intends to have a 50:50 mix of LTL and logistics revenues. Last year, the company posted $2.1 bn in LTL revenues and $950 mn in logistics revenue. So, we are talking about another $1 bn in logistics revenues, if the company is able to execute its strategy. Third-party logistics service providers like C. H. Robinson (CHRW) have operating margins in mid to high single digit range. If ArcBest is able to reach and stabilize this business at $2 bn revenues and earn mid-single digit operating margins, this would mean a substantial upside both for operating profit and stock price.

Needs more work

Investors aren’t expecting much growth from the company’s LTL business and how the company executes on its third-party logistics business will be the key for its stock price appreciation. 2018 was a good year for the company’s third-party logistics business. Tight demand conditions meant a lot of demand for ArcBest’s expedited service which has high profit margins.

With the Industrial end-market seeing tariff-related headwind last year, the demand supply situation loosened and shippers now have a greater number of lower cost capacity options thus reducing their need for expedited services.

ArcBest is not the only third-party logistics company which disappointed in 2019. Even C. H. Robinson posted lower than expected results and was impacted by the broader macroeconomic environment. Since ArcBest is just getting started in third-party logistics business versus its more established peer, it is likely that its business will see much more volatility compared to others. Usually, investors tend to extrapolate what they are seeing currently. In 2018, when things were going great, the stock was trading in high 40s. Currently, when the business is not doing great, the stock is trading in low to mid 20s.

I believe a contrarian bet makes much more sense in these times. I don’t think investors are giving any credit to ArcBest for its third-party logistics business at the current price. So, there is a good upside if execution improves and little downside if things go wrong.

The company is focusing on growing its managed transportation business. This solution resonates with customers who want ArcBest to coordinate their supply chain in a cost-efficient manner while maintaining a focus on service and transit reliability. Management believe it can cross sell its brokerage services to existing LTL clients who have shown high level of interest in the company’s offering.

Source: ArcBest Earnings Presentation

Stock is attractively priced

ArcBest is cheap. The company’s total stockholder equity on its balance sheet for year-end 2019 is $763 mn or $29.93 per share (based on 25.49 mn share count). Even if we remove $88 mn of goodwill and $59 mn of other intangible assets, we have $616 mn in shareholder equity or $24.16 per share.

The stock is trading at 0.82x Book Value. Even if we exclude goodwill and net intangible assets, the stock is trading at 1.01x Book Value. The stock is trading at 10x FY 2020 and 8.5x FY 2021 consensus EPS estimates. It is rare to find a profitable company trading at such a low valuation in this market. Management has adopted the right strategy in terms of growing its asset-light business which is not unionized. However, uneven execution both in terms of revenue growth and profitability in this business is impacting investor sentiments. If management is able to deliver some consistency in this business, the stock can see a good upside. I rate the stock a buy because of low valuations. Plus there is good upside potential if its execution improves on the asset-light side.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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