Ryder System: Still Cheap Going Into 2023 (NYSE:R)

Dear readers/followers,

Logistic plays can be attractive investments. They have an inherent amount of cyclicality, but in times of strain and demand for logistics, their earnings can go to absolutely insane levels. This has been evidenced by the way Ryder (NYSE:R) has been developing.

Since writing about it last time, Ryder has been outperforming the broader market. My investment is firmly up. This especially goes for my first bullish call on the company, which has seen over 35% outperformance over the broader indexes.

Ryder – An update

So, since we have a 15% RoR, the time has come to look at Ryder again from a valuation lens. There hasn’t been any marked or fundamental change in the company’s potential since I wrote about it last. Ryder is still the same fundamentally attractive and appealing business it was “30% ago”.

Since its inception 80+ years ago, Ryder has, since then, growing to encompass almost 43,000 employees in two nations, the United States and the United Kingdom, and today has revenues of nearly $10B, and that 20-50 truck fleet in the 1930s now encompasses almost 260,000 vehicles today.

The company has 800 maintenance locations, and the customers are quite simple in every single segment and end market you could imagine.

Logistics is all about scale these days. If you’re a smaller operator, the margins, costs, fees, inflation, gas prices and other variables will eat your company from the inside. The big players make do with incredibly closely-calculated efficiencies of scale. The simple fact is, that most companies trying to enter the space or do their own logistics come to one inescapable conclusion when doing the math.

That they may be better off not owning their own logistical solutions or assets, but rather might prefer to outsource these to a third party who make it their business to address all of these challenges.

And that’s Ryder. Ryder is a “plug-and-play” logistics solution that can be scaled to most sizes. It is a full-service logistics provider, whose revenue profile is mostly contractual, providing Ryder with a multi-year stable OCF while also reflecting an increased desire from customers to outsource their logistical solutions.

The company’s basic operating segments are two – Commercial Rental and ChoiceLease/DTS/SCS. All of these target the ambition of locking in longer-term revenue flows for the company. On a high level, the commercial renting service that’s also the smaller part (less than 20%) of revenues is also the more CapEx-intensive of the two businesses.

So from a strategic point of view, the company is looking to lower its commercial renting and move forward with ChoiceLease/DTS/STS.

The latest results we have for Ryder come in the form of 3Q22 – and those results are unsurprising. The company continues to report 2022 growth, with solid sales momentum and record YTD contractual sales. Despite delays in vehicles, the company’s lease fleet returned to growth.

I want to emphasize here that outsourcing these services is the new normal. This is what’s driving Ryder, and what is continued to be expected to drive the company forward.

Metrics continue to be solid. The company’s Return on Equity shows a 30% mark, meaning among the best in the entire industry, and the company’s SCS/DTS segments achieved their target returns in 3Q22, reflecting both the company’s pricing and the customer’s willingness to accept this pricing.

Top-line results saw improvements of 18% YoY, and EPS is coming in accordance with the blockbuster 2022E expectation. FCF is more or less flat, but this is due to increased overall CapEx.

Used vehicle sales numbers, which are one of the company’s ways of attractively divesting assets it no longer deems profitable enough, are also still above the norm. While not as high as earlier in 2022, the proceeds in 3Q22 are still 14% above par for tractors and over 25% above the YoY level for trucks – and it continues to hold a used vehicle inventory of over 4,500 units, which is below the long-term target range of 7-9k units, marking clearly how thinly stretched the used market for these vehicles is.

SCD was the real outperformer during 3Q22.

It’s in line with the longer-term high-single-digit target, and the market is good. The same positive trends can be seen for DTS, with superb trends from new business flows as well as higher service pricing. There is a pricing elasticity to the company’s services and products that, it seems, has yet to meet any sort of resistance.

CapEx, naturally, is up significantly. The leasing CapEx is approaching double levels YoY, reflecting the company’s higher replacement capital for the segment, while the CapEx for Rentals is actually falling quite a bit…

The reason for this is that the company is executing on its strategy to make rentals less of a thing for Ryder. They don’t want to be a new U-Haul, rather they want to be a long-term leaser, which makes complete sense from a high level. The company’s RoE, as a result of in part of this, has increased massively, and FCF is showing some positive stability.

The structural changes that Ryder is making to its business model are working.

That we’re seeing a cycle peak in 2022 is no doubt. I would go so far as to say that the decline in 2023 is almost guaranteed at this point, and the way things are looking. For 2022E, we’re looking at GAAP forecasts in the range of $16.6 on the high end, which would mark improvements of above 65% YoY. After 2022 though, that’s forecasted by most analysts to drop down to $10-$11 – which is still above 2021 levels, though most are also forecasting a decline in 2024.

One of the core things you want to be looking at when comparing this company to peers is the amount of CapEx on a per-vehicle or per-segment basis. Initial cash flows in vehicle payments are recaptured through lease and rental payments, and no lease capital is committed until contracts are signed. The nature of Ryder FCF is counter-cyclical to GDP and macro, with 2020 record FCF of almost $1.6B reflecting lower lease and capital spending due to COVID-19 (and yet despite this lower spending, record incomes). That means the current expected downturn is natural in terms of the cycle. Not even the company’s ongoing savings can really turn this around with any sort of efficiency in the near term.

Ryder knows what it wants and what it targets – and it also closed its M&A of Baton, a start-up that focuses on optimizing transportation networks, which the company has been following for 2-3 years.

All in all, the company is working as expected, and earnings and results are coming in either at the levels or slightly above the levels I expected them to.

Let’s see that company valuation and what we can expect here.

Ryder – The Valuation

Ryder’s valuation is showing impressive trends given where results have been for the past 2 years. We’re still trading at a blended P/E of 5.27x at this time, which is actually below the level I saw in my absolute first article on the company due to increased forecast levels. However, this is and remains heavily impacted by the massive post-pandemic earnings growths, which have driven EPS to double digits compared to what was Pre-COVID $4-$6 EPS for the company.

The question about Ryder becomes normalization – and once we start seeing some of those 2023 reports hit the market, we’ll know better which direction this industry is moving and where we can expect their long-term earnings to cycle down, so to speak.

For GAAP, we have S&P Global and FactSet analysts expecting the company’s EPS to normalize somewhere close to the double-digit level, and not fall much further. Of course, this assumes the expected growth in the company’s SCS/DTS segments.

Also, it’s important to point out that at this time, dividend cuts aren’t on the table – not if you follow some of the analysts here at least.

The company remains BBB rated, and despite a relatively modest market cap of just over $4B, is, I would say, a quality sort of business with a decent sort of upside.

Competition for Ryder remains fairly easy to deduce. A business may choose not to outsource its fleet management services, or obtain services from similar vendors – and there is no shortage of such competition.

It’s both a regional and national market, with plenty of peers. It’s still, despite Ryder and other logistics solutions, a very fragmented market. Ryder competes with finance lessors, truck/trailer manufacturers, and independent dealers providing full-service solutions and products. Further legacy competition comes from managed maintenance providers.

Some of the companies that do offer Ryder’s services or similar ones include Old Dominion Freight (ODFL), J.B. Hunt (JBHT), Avis (CAR), Knight-Swift (KNX), Werner (WERN), and others. Many of these are relatively unknown names in the broader sense of things.

However, the advantage that Ryder offers comes in the form of a straight valuation.

I believe full normalization of earnings will take place in the $8.5-$11 range when we look at adjusted EPS. And $8.5 is really the lowest I believe it will go, based on combining inflation outlooks with the company’s change in targets, with price increases, with updating DCF models and NAV valuations. Any lower than that would require substantial discounting of a company or parts of it that I, even in a recession, don’t view as valid here.

S&P Global analysts follow the business – 6 of them. They give it a range of $81 on the low side to $96 on the high side. $96 would imply a 2023-2024E normalized P/E of 9x to the company’s normalized earnings of around double digits. I view this as still too low for the long term, but I understand the case due to the forecast uncertainty at this point. Moreover, the average S&P Global target is below that, at $89/share. So, analysts are heavily discounting Ryder here – and there is forecast accuracy-related reasons for that.

I would say in this update that you’re looking to pay below $90/share, which makes the company’s current price very attractive.

There is room for upward improvement in the current valuation due to the expectations for this year, and I wouldn’t say that the decline for the coming 1-2 years is as clearly established or expected as this might suggest. The company does have a tendency to at times beat expectations, and given the state of the industry today, I wouldn’t bet against one of the bigger transport/logistical companies in its field.

My continued thesis for Ryder is “BUY”, and I’m raising my target by $4 per share.

Thesis

The thesis for Ryder Is a fairly simple one.

• Ryder is an undervalued trucking/transport company that’s shifting from renting to leasing and has a significant conservative upside to where it’s currently trading at. I would consider this company a “BUY” with a significant upside to a conservative PT of $84/share.
• The company’s drivers include increased demand and industry consolidation to outsourcing of logistical solutions, efficiencies, and experience. The risks are increased competition and a somewhat higher debt level than we might like to see.
• Overall, the pros and cons clearly come out in Ryder’s favor.

Remember, I’m all about:

• Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

It’s still a “BUY” here.