In December, I said from a “full-cycle perspective, the five-year average free cash flow for YRC Worldwide (YRCW) is $152 million, and the current yield based on that figure is 6.6% – twice the Treasury yield.

Twice the Treasury yield would normally justify the investment, particularly for investors who are either more optimistic or more risk-tolerant than I am. But given that Landstar (LSTR - Annual Report) is yielding even more and has less risk (in my opinion) over the full cycle it isn’t enough to make me switch.”

Since that time, YRC has declined 25.5%, while Landstar is up 34.6% since I said I expected it to shine again.

As to the question of relative risk, Landstar is virtually debt free, while YRC has loads of debt and recently received a downgrade. As a result, it renegotiated its credit agreement. Until the company’s credit rating is restored to BBB- or better, the Credit Agreement Amendment:

• increases, the Company’s allowable Total Leverage Ratio (as defined in the Credit Facility) from 3.0x to (i) 3.75x for each of the fiscal quarters ended March 31, June 30 and September 30, 2008 and (ii) 3.5x for each fiscal quarter thereafter;

• increases the interest rates and fees applicable to the revolving credit facility; the Company expects interest expense to increase $1.5 – 4.0 million annually with this amendment;

• requires the Company and its domestic subsidiaries to pledge additional collateral;

• requires the Company and its subsidiaries to pledge additional assets, including rolling stock and the remaining real estate if the Total Leverage Ratio exceeds 3.5x at the end of any Test Period (as defined in the Credit Facility) or if the Company receives a rating of BB- or worse from Standard & Poor’s and Ba3 or worse;

• requires each domestic subsidiary of the Company except for YRRFC (as defined below) to guarantee the credit facility; and

• modifies certain negative covenants (and in certain instances introduces new negative covenants) related to permitted liens, permitted acquisitions, permitted asset sales (and certain related mandatory prepayments from the proceeds thereof) and restricted payments.

I fully expect YRC to survive, and at some point it will make for a good trade, as the leverage works in the other direction. In the meantime, I’m glad I am positioned the way I am.

Disclosure: At time of publication, William Trent is long Landstar (LSTR - Annual Report).

Landstar System, Inc. (LSTR - Annual Report) reported revenue in the 2008 first quarter increased approximately 6 percent to $609 million compared to $577 million for the 2007 first quarter. Net income for the thirteen-week period ended March 29, 2008 was $23.7 million, or $0.45 per diluted share, compared to net income of $21.6 million, or $0.38 per diluted share, for the thirteen-week period ended March 31, 2007.

The midpoint of the $0.51 to $0.57 guidance range for the second quarter was ahead of the $0.53 consensus.

I have said before that I would be willing to own Landstar up to a parity yield with Treasuries, because I think the growth alone is sufficient premium for the risk. Based on the 2007 cash flows and the current yield on 5-year Treasuries, that implies a potential price of $84 – so its safe to say I don’t expect to sell any time soon.

Disclosure: At time of publication, William Trent owns shares of Landstar

photo credit: atennies94

The following article is a reprint of my February 27, 2008 RealMoney column.

A long UPS/short FDX paired trade could work, but I’d wait for a pullback to $65 before UPS would tempt me as a long-only play.

My bullish November 2007 Landstar (LSTR - Annual Report) column represents my most successful pick for RealMoney to date. The stock is up 20%, compared to a 6% decline in the S&P 500. Landstar has also outperformed CH Robinson (CHRW - Annual Report) by 9% since I predicted as much in December, and YRC Worldwide (YRCW) has underperformed the S&P by 10% since I advised looking elsewhere.

Given that my transportation picks seem to be working out better than my others, I decided to push my luck with another long-short idea. This time, I think United Parcel Service (UPS) can continue its recent outperformance relative to FedEx (FDX - Annual Report).

Two years ago, I wrote briefly about the relationship on my blog, saying:

FDX has greater operating leverage and will continue to outperform as long as the economy continues to expand and trucking capacity remains tight…. Timing this switch is the difficult part.

Over those two years, the timing has clearly happened. UPS has outperformed FedEx by about 10% since then, and by 25% in the last 12 months.

Other than the operating leverage, I think the stocks are similar enough that a long-short trade would truly offset much of the risks. Clearly the macroeconomic and industry exposures are similar.

FedEx is expected to grow slightly faster (15% compared to 13% for UPS) over the next five years and has a lower P/E multiple. But UPS generates far more free cash flow. The free cash flow yield at UPS is 5.3%, compared to just 2% at FedEx. The cash flows can be used to buy back shares, pay dividends, or make acquisitions. All of these could boost the EPS growth rate for UPS. Because of the higher yield, I think there is much less downside for UPS.

UPS also tends to have slightly higher earnings quality, on average, than FedEx. I use the accrual ratio, which measures the difference between cash earnings and accounting earnings, as a proxy for earnings quality. This ratio is less volatile for UPS and tends to be closer to zero in most periods, both of which give me more confidence in the earnings reported by UPS (though earnings quality at FedEx is by no means poor.)

Source: Zacks Research Wizard, compiled by William Trent

The differences in performance, however, are only relative. Long-only investors have been disappointed by UPS over time, with the shares trading within 10% of the current price for the last two years, and within 20% for the last five. In fact, UPS is almost exactly in the middle of its long-term trading range.

I think the future performance will remain uninspiring. The 5.3% free cash flow yield is reasonable and offers some downside protection, but is not enough to juice returns. At roughly five times book value and 16 times earnings, I don’t see a huge opportunity for expanding valuation. The tight trading range has also means there is little advantage to a put-write strategy. Low stock volatility means the March $70 puts offer just over a 1% premium. That isn’t enough for taking the risk that the stock falls to the low end of its trading range – though I’d be much more favorably disposed toward UPS if the stock pulled back to $65 or so.

For the reasons outlined above, I think a paired trade going long UPS and short FedEx could continue to work over the next few months.

Disclosures: William Trent is long Landstar (LSTR - Annual Report)

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

In December I wrote:

Nobody believes trucking company YRC Worldwide (YRCW) will earn the consensus estimate of $2.52 per share in 2008. If they did, the stock would be trading significantly higher than $17.50 per share.

After all, the company earned $5.00 per share in 2006 and is expected to pull in $2.40 this year.

Well, the $2.40 in 2007 turned out to be $1.88 – and that is only if you ignore $12.77 per share of impairment charges. Although the charges did not affect cash flows in 2007, they indicate that earnings in years gone by were higher than should have been reported in retrospect.

Since the article, the shares are down nearly 16%, compared with an 11% decline in the S&P 500. At one point the shares traded below $12 per share. Meanwhile, my favored trucking play, Landstar (LSTR - Annual Report) is up more than 5%. I still think Landstar offers a more compelling valuation and lower risk over the full economic cycle.

Disclosure: William A. Trent owns shares of Landstar (LSTR - Annual Report) at the time of publication.

The following is my RealMoney column from December 6, 2006.

YRCW shares are pricing in a much lower EPS outlook than the consensus. Does that signal a buying opportunity?

Nobody believes trucking company YRC Worldwide (YRCW) will earn the consensus estimate of $2.52 per share in 2008. If they did, the stock would be trading significantly higher than $17.50 per share.

After all, the company earned $5.00 per share in 2006 and is expected to pull in $2.40 this year. If this year is really “the bottom” for earnings investors should be willing to pay at least $30, which equates to the company’s 5-year average P/E of 12x.

So investors clearly think YRC will earn less – probably much less – than $2.52. The questions then become:

1. How much less will they earn?
2. Does the current price reflect the worst case scenario?
3. If nobody believes YRC will earn $2.52 how did it become the consensus estimate?

I’ll leave the last question to philosophers, but I think I can take a stab at the first two.

How Low Can They Go?

To get a feel for the potential earnings bottom, I looked at the history available from Zacks Research Wizard.

Source: Zacks Research Wizard

Clearly the earnings per share can be much lower than $2.52. In fact, the last economic slowdown included one year that wiped out the peak year, the subsequent down year and a good part of the next year’s recovery. Furthermore, the late 1990’s also indicate that several down years can wipe out a good deal of the positive earnings in up years. All of which goes to show why I prefer the non-asset based transportation companies like Landstar (LSTR - Annual Report) and CH Robinson (CHRW - Annual Report).

So one approach to valuation would be to take a page from Ben Graham’s Intelligent Investor (page 313 in my edition) and use a longer-term average of earnings per share. I chose five years, giving me the following chart.

Sources: Zacks Research Wizard, William A. Trent

Right away, I see two useful take-aways from this chart. One is that the trough-peak pattern from 1999-2001 looks very similar to the one in 2004-2005. This gives me some confidence that this cyclical relationship may represent the next cycle as well. The other is that the cumulative peak-peak growth rate from 2001-2006 is about 25%.

Applying 25% growth from the 2004 trough gives me a target for the average EPS in the next trough – about $0.44. This helps me answer the first question (as well as some indication of how severe the negative earnings year(s) will have to be in order to push the 5-year average that low.)

Is the worst case priced in?

An old rule of thumb is to buy cyclical stocks when the P/E is high and sell when it is low. This is because the P/E is high when earnings are at their lowest and about to recover. Just looking at the estimates, though, the current P/E is low.

But we already established that the estimates aren’t believed. If the five-year average earnings per share is about to drop to $0.44, the stock is currently trading at about 40x trough earnings. That is starting to sound like the “high P/E” that would signal a buy.

And whaddya know? It looks from this chart that as YRC started to pull out of the last earnings trough it was getting a multiple of about 40x earnings. Furthermore, the stock is now trading below its levels five years ago even though the general EPS trend has been up.

This doesn’t, of course, imply that the worst is priced in. Nobody can really know that for sure. But it sure looks like we’re getting close.

Cash Flow Talks

Of course, I always prefer to look at companies on a cash flow basis rather than an earnings basis. Free cash flow (cash from operations less capital expenditures) has been negative for the last three quarters. Over the trailing 12 months it comes to $68 million – a 3% yield on the $2.3 billion enterprise value.

Ideally, in exchange for accepting the risk related to a stock like YRCW I would to get a higher return than I would from other investments like a 3.3% 5-year Treasury bond. Although the current free cash flow yield for YRC is less than the Treasury yield, if the risk is mostly reflected then proximity to the risk-free rate isn’t necessarily bad.

Once again turning to a full-cycle perspective, the five-year average free cash flow for YRC is $152 million, and the current yield based on that figure is 6.6% – twice the Treasury yield.

Twice the Treasury yield would normally justify the investment, particularly for investors who are either more optimistic or more risk-tolerant than I am. But given that Landstar is yielding even more and has less risk (in my opinion) over the full cycle it isn’t enough to make me switch.

Disclosure: William Trent is long Landstar (LSTR - Annual Report)

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

The following is my RealMoney article from December 4, 2007.

A Tale of Two Truckers

The valuation discrepancy between Landstar (LSTR - Annual Report) and CH Robinson (CHRW - Annual Report) may present a paired-trade opportunity to be long Landstar and short CH Robinson.

A couple of weeks ago I predicted Landstar’s stock would shine again, and the first evidence of that was provided with the company’s positive mid-quarter update.

The shares were up more than 5% after the call, but it will be a while before I am ready to sell. Even after yesterday’s rally, the shares are yielding 7.1% free cash flow to enterprise value. With the five-year Treasury at 3.4%, that still amounts to more than a 100% premium, and Landstar should still provide growth.

In fact, I would be willing to own Landstar up to a parity yield with Treasuries, because I believe the growth alone is sufficient premium for the risk. On that basis, and with today’s Treasury yield and trailing Landstar FCF, I get an implied value of nearly $90 per share.

Am I Being Overly Optimistic?

That may at first blush sound like an overly optimistic forecast for a stock trading at $42. But a glance at the company’s most similar peer, C.H. Robinson, suggests it may be warranted. CHRW is trading at a free cash flow yield of just 3.1%, which would allow for even more upside than my own prognostication.

To be sure, CH Robinson is a great company, and in 2007 is showing much higher growth – an estimated 20% compared to a flat year for Landstar. But as I mentioned in my original piece, Landstar provides disaster-relief services for FEMA, and the milder hurricane season in 2006 led to lower revenue in early 2007 than was experienced after Katrina and Rita for 2005/2006.

According to Landstar’s latest 10Q, revenue would have been up 5% excluding FEMA business in both years. And for next year, analysts are predicting 15% growth at CHRW and 13.3% at LSTR – pretty close to parity if you ask me.

Are the Companies Really Peers?

The next fair question to ask is whether the companies are truly peers, or if the valuation discrepancy is otherwise justified. CH Robinson is much larger, with $7 billion in trailing-year revenues compared to $2.5 billion for Landstar. Landstar’s $185 million in operating income is also a fraction of the $497 million CH Robinson earned.

But size alone does not justify a huge valuation premium. And judging from the way the companies describe themselves, they sure do seem like peers.

In its 10Q, CH Robinson says “we are a non-asset based transportation provider, meaning we do not own the transportation equipment that is used to transport our customer’s freight.”

By comparison, “Landstar’s business strategy is to be a non-asset based provider of transportation capacity and logistics services delivering safe, specialized transportation services globally, utilizing a network of independent commission sales agents, third party capacity providers and employees,” according to it’s 10Q.

Looking at the ratios, the companies still seem like peers and if anything Landstar might deserve the higher multiples:

Even the stock chart suggests the companies are peers, as they have tracked each other fairly closely for the last five years.

Am I Using the Right Valuation Measure?

The only remaining concern is whether my choice of free cash flow yield is picking and choosing a valuation method that fits my thesis. So, I look at several other possible valuations.

Based solely on sales or operating margins, Landstar is about 35% the size of CH Robinson. If it had the same relative valuation it would trade at $52 per share.

CH Robinson’s forward P/E multiple is 24.6, compared to 19.3 for Landstar. At 24.6x estimated 2008 earnings, Landstar would be trading north of $54. Assigning CHRW’s 1.67 PEG ratio to Landstar would give it a $49 value.

CH Robinson has a lofty 16.1x EV/EBITDA ratio. If Landstar got that multiple its stock would be $60.

In fact, the only comparison by which Landstar looks more highly valued is price/book – and Landstar’s higher return on equity indicates that that multiple may also be the least valid comparison.

The more I look at it, the more I think Landstar and CH Robinson would make for a great paired trade. Both are great companies, but Landstar clearly seems like the better stock right now.

Disclosure: William Trent is long Landstar.

A couple of weeks ago I was afforded a rare opportunity to buy one of my favorite stocks, Landstar (LSTR - Annual Report), at what I considered to be a bargain basement price. As I said at the time:

Over the last 12 months, Landstar generated $167 million in free cash flow. Nearly all of its operating cash goes to share repurchases and dividends since the company isn’t buying trucks. On a $2.1 billion enterprise value, that amounts to an 8% free cash flow yield – more than twice the yield on Treasury bonds and a healthy risk premium in today’s market.

What’s more, Landstar’s 5% apples-to-apples growth in a bad year suggests the longer-term growth rate could be significantly higher. With today’s price justified even without any growth, the prospect of an eventual return to double-digit growth rates gets my mouth watering.

I was prepared to wait a while before earning significant returns, but Landstar got me a good way along during its mid-quarter conference call yesterday.

Landstar affirms 4th-quarter profit view (Reuters):

Chief Executive Henry Gerkens said on a conference call he was “very comfortable” with the company’s October forecast, which calls for earnings-per-share in a range of 47 cents to 52 cents.Analysts, on average, were looking for Landstar to earn 49 cents per share on sales of $624 million, according to Reuters Estimates.

The shares were up more than 5% after the call, but it will be a while before I am ready to sell. Even after yesterday’s rally the shares are yielding 7.1% free cash flow-to-enterprise value. With the 5-year Treasury at 3.4%, that still amounts to more than a 100% premium, and Landstar should still provide growth.

In fact, I would be willing to own Landstar up to a parity yield with Treasuries, because I think the growth alone is sufficient premium for the risk. On that basis, and with today’s Treasury yield and trailing Landstar FCF, I get an implied value of nearly $90 per share. Obviously both variables could change over time, and a fall in Landstar’s free cash flow or a rise in interest rates would indicate a lower possible value. But at any rate, I feel like I have quite a margin of safety.

This column originally appeared at RealMoney on November 19, 2007

Along with most of the rest of the trucking industry, the news on Friday from FedEx (FDX - Annual Report) and YRC Worldwide (YRCW) sent shares of Landstar (LSTR - Annual Report) down sharply, briefly causing it to breach the 52-week low. Landstar has long been one of my favorite names, and I took the opportunity to buy some shares because I think the current valuation will be tough to beat.

Don’t get me wrong – I’m not arguing that trucking revenues are about to ramp up across the board. As the chart below shows, the industry has been slowing since early 2006 and despite the little uptick in September the year/year change was a decline of 2.3%. Demand for trucking services is bad, and the slowing U.S. consumer suggests that it will probably get worse before it gets better.

Source: American Trucking Associations

No, the main reason I like Landstar for the long haul (har!) is their business model. Rather than own their own trucks, they outsource the loads to owner operators who provide their own rigs. The business capacity owners (BCOs in Landstar terminology) get the lion’s share of the revenue for the load, which encourages them to haul as many as they can. This is a virtuous cycle that benefits both Landstar and their BCOs. More than 30,000 rigs are in the Landstar network, though some are much more active than others.

But the benefit isn’t just incentives to work harder. The revenue sharing process means that most of Landstar’s expenses are variable rather than fixed. When business is slowing for the trucking industry as a whole, Landstar’s expenses fall in proportion to any decline in revenues and the company is able to remain profitable.

For regular trucking companies like YRC, each unassigned truck is a drag on profitability. The truck certainly represents a depreciation expense and could also represent an economic expense if it is leased or purchased on credit. Every truck without a driver hurts the company.

At Landstar, an empty truck hurts the driver, who then has that much more incentive to haul some merchandise, earn some money and make the truck payment.

Industry Slowdown?

Although Landstar reported a 3% decline in total revenue during the first nine months of 2007, the decline was mostly due to a fall-off in one contract. The company provides disaster-relief services for FEMA and the milder hurricane season in 2006 led to lower revenue in early 2007 than was experienced post Katrina and Rita for 2005/2006.

According to Landstar’s latest 10Q, revenue would have been up 5% excluding FEMA business in both years. Contrast that with the decline in overall industry revenues, and I smell market share gains. The industry may be slowing down, but I don’t think Landstar is.

Cheap Growth

Over the last 12 months, Landstar generated $167 million in free cash flow. Nearly all of its operating cash goes to share repurchases and dividends since the company isn’t buying trucks. On a $2.1 billion enterprise value, that amounts to an 8% free cash flow yield – more than twice the yield on Treasury bonds and a healthy risk premium in today’s market.

What’s more, Landstar’s 5% apples-to-apples growth in a bad year suggests the longer-term growth rate could be significantly higher. With today’s price justified even without any growth, the prospect of an eventual return to double-digit growth rates gets my mouth watering.

Sure, the P/E of 17x is significantly higher than YRC’s 6x. But the lack of capital requirements, the absence of YRC’s $1.5 billion in debt and the variable cost nature more than justify the higher P/E in my opinion.

Disclosure: William Trent owns shares of Landstar (LSTR - Annual Report)

Last October I said “I would not own Green Eggs or Yellow Trucks.”

As the economy slows, those companies like CH Robinson (CHRW – Annual Report) and Landstar (LSTR – Annual Report) that get their capacity from independent contractors on an as-needed basis have lower overhead expenses and remain profitable. If the economy slows much further, Yellow’s guidance reductions will be even larger.

My lack of appetite was well founded, as trucker YRC Worldwide (YRCW) – the trucker formerly known as Yellow – is down 22% since then while CH Robinson and Landstar are flat or up. As to the economy, the ATA trucking index says it all:

The American Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index decreased 0.1 percent in June, marking the third consecutive month-to-month drop. Tonnage fell 1.3 percent in May and has dropped 3.5 percent since March. The not seasonally adjusted index dropped 3.3 percent from May to 114.1.

On a seasonally adjusted basis, the tonnage index declined to a seven-month low of 110.5 (2000 = 100) in June from 110.6 the previous month. Compared with a year earlier, tonnage was down 3.4 percent in June, which is just a slight improvement from the 3.6 percent year-over-year decrease in May.

Meanwhile, Yellow’s guidance reductions have indeed been large. From initial expectations of $5.65-$5.85 for 2006 the company ended up earning just $5.00. What had once been expected to be an up year in 2007 is now forecast at just $3.17 and estimates have been steadily dropping for the last 90 days. It is probably safe to say that few investors believe the $3.81 forecast for 2008.

But still, even with the current depressed earnings there are earnings. Further, it looks like it would take a significant further decline for the company to end up with a loss. The trailing twelve month EV/EBITDA is a mere 4.35x. Given that the cycle peak earnings should still someday be in the $6.00 range the stock is starting to look like a bargain.

I’m not the only one who thinks so, either. According to StockPickr, the January 35 calls have seen unusually high trading volume lately. I’m thinking those traders may be on to something.

Large Cap Watch List (Track at Marketocracy) member YRC Worldwide Inc. (YRCW) today announced reported diluted earnings per share (”EPS”) for the second quarter 2007 of $0.95 compared to $1.58 in the second quarter last year. Adjusted diluted EPS was $0.91, compared to $1.62 for the second quarter 2006.

Although the results looked awful, the signs of a poor environment for transportation had been building. The shares actually rallied in after-hours trading, suggesting that investors may have feared worse or even think that the bottom has been reached. I doubt that latter point, but of course I’ve been wrong before.

YRC management, however seems to agree with me on this one. They offered guidance for a litany of line items  ranging from interest expense to tax rate to shares outstanding. As far as revenue and earnings, however, your guess is apparently as good as theirs. At least whatever number you come up with, you’ll have a decent idea how much interest to expense, how much tax to reduce it by and how many shares to divide it by to arrive at EPS.

The company managed to increase its cash flow from operating activities slightly, but also managed to spend more than it generated buying new trucks.  Which is one more reason to prefer Landstar (LSTR - Annual Report) and CH Robinson (CHRW - Annual Report).