The trucking industry continues to rebound alongside the general economy, with the American Trucking Association's (ATA) Tonnage Index rising 6.9% in August 2013 versus the prior year. However, more consolidation seems to be a foregone conclusion for the industry, as government regulation tightens, especially in the areas of driving hours and safety.
Knight Transportation (NYSE: KNX ) jumped on the consolidation bandwagon in late September, offering to buy competitor USA Truck (NASDAQ: USAK ) for a nice premium. With USA Truck's management rejecting the offer and retrenching, should investors bet on further upside?
What's the value?
USA Truck is primarily a trucking company that hauls cargo from origin to destination for a single customer, a category commonly known as the truckload segment. In contrast, competitors like Old Dominion Freight Line (NASDAQ: ODFL ) and SAIA (NASDAQ: SAIA ) have focused on the faster growing, less-than-truckload category, which more efficiently carries cargo for multiple customers, but also requires a large network of service centers.
Unfortunately, USA Truck has had trouble finding operating profitability over the past five years. It spread its resources over too wide a geographic area, and its trucks' productivity suffered, as evidenced by a 19% decline in its per tractor usage from 2008 to 2012.
In FY 2013, though, USA Truck's management has done an about-face on its strategy, reducing its operating footprint to create greater density and better asset productivity. The strategy shift has generated financial dividends for the company, as a higher per-tractor usage level and a better pricing environment led to a 112% increase in its EBITDA. In addition, USA Truck has benefited from growth in the freight brokerage area, a segment that has produced double-digit operating profit growth in the current period.
For its part, Knight Transportation likely sees an opportunity to acquire a rebounding competitor's assets on the cheap, given USA Truck's current market valuation at roughly 20% above book value. Despite a similar focus on the truckload segment, Knight has been profitable across business environments, thanks to its focus on being a low-cost provider and limiting its service markets to areas where it has critical mass. Consistent profitability has allowed the company to operate relatively debt-free, while providing the funds for its capital expenditure purchases.
In FY 2013, Knight has continued rolling, with a 5.4% increase in revenues and a double-digit increase in operating profit. Knight's average base of tractors declined compared to the prior-year period, but it benefited from better pricing and overall usage of its fleet. More importantly, the company has generated strong operating cash flow, $72 million during the period, providing a solid foundation to fund an acquisition offer.
Best of Breed
While USA Truck is an interesting turnaround story, with or without a deal, it is still reporting operating losses and needs to continue building greater scale in its core markets to reach profitability.
As such, investors would likely find better long run returns with profitable competitors that are focused on the growing less-than-truckload segment, like Old Dominion and SAIA. The two companies have enjoyed a strong pickup in operating profit over the past five years, not to mention sharply higher stock prices, by building out national service center bases that allowed them to enter new markets.
In FY2013, both companies have generated double-digit gains in operating profit, with increases of 19.5% and 17.4% for Old Dominion and SAIA, respectively. They have benefited from top-line growth, better shipment pricing and more favorable operating costs, especially in the area of fuel expenditures. More importantly, solid profitability allows both companies to operate with relatively low debt levels and reinvest in new equipment to increase their scale and efficiency, leading to future growth opportunities.
The bottom line
Given a roughly 11% stake in USA Truck, Knight looks unlikely to walk away from its offer of $9 per share or roughly $95 million. It will probably need to raise its price, since USA Truck's shares currently sit well above the offer price. Absent a transaction, though, investors would probably want to wait for better financial results to percolate before allocating funds to this turnaround story.
Instead, investors should take a closer look at the players that have built valuable service centers and are positioned to capture market share and future growth -- namely, Old Dominion and SAIA.