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CAPScall of the Week: Quality Distribution

By Sean Williams - Dec 11, 2012 at 1:41PM

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A weekly adventure in giving unknown companies some attention.

For years, satirical late-night-TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database, and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'd like to take a closer look at Quality Distribution (NASDAQ: QLTY).

What Quality Distribution does
Quality Distribution is comprised of three business operations, including the transportation of bulk chemicals (by far its largest revenue generator), its intermodal tank container and depot service operations, and its energy logistics segment consisting of logistics and transportation services for the more unconventional players in oil and gas industry, with a specific focus on the shale natural gas industry.

In Quality Distribution's most recent quarter management noted that, despite an 11.4% increase in revenue, profits declined across all three business segments. Some of the blame was passed off on Superstorm Sandy, but weakness in natural gas pricing and drilling activity, slow integration of new energy logistic acquisitions, and higher equipment repair and health benefit costs in its intermodal business dragged down its results. 

Whom it competes against
As often happens when I profile little-known but highly specialized companies in this series, it isn't competitors that Quality Distribution has to worry about so much as the overall state of the chemical, trucking, and drilling industries.

Recently, things have been challenging on all three fronts for Quality Distribution. The biggest name in chemicals, DuPont (DD), recorded a 98% tumble in profits in its third-quarter report as demand for titanium dioxide (a primary paint pigment component) dropped, and it announced a round of 1,500 layoffs to reduce expenses. 

In intermodal and logistics, we've seen demand down across the board. Werner Enterprises (WERN 1.78%) reported a 15% decline in profits in the third quarter as a cauldron of softer freight demand and rising fuel costs crushed margins. Even behemoth FedEx (FDX -1.14%) fell under the guillotine, succumbing to softer premium shipping demand as consumers opted for two- or three-day shipping instead of higher margin overnight rates, and overseas businesses utilized shippers instead of air freight for delivery.

Finally, in the energy sector, drillers have been cutting back production in response to weak pricing. Chesapeake Energy (CHKA.Q) might be the poster child for this, reducing its natural gas drilling expenditures by roughly 70%.

Behind all of these moves is the uncertainty surrounding global growth trends as well. In order for Quality Distribution's business to take off, it needs strong domestic growth, as well as improvement in exports to China and Europe to drive further transport needs.

The call
After carefully reviewing the prospects for Quality Distribution, I've decided to follow the crowd and make a CAPScall of outperform on the company.

Despite just 92 members having made a CAPScall on the company, 89 of them are in favor of Quality Distribution outperforming and I happen to agree with the majority wholeheartedly in this case.

To begin with, management sees double-digit organic growth potential in its energy logistics segment over the near future. Natural gas prices have rebounded significantly from their lows and with the Obama administration pushing to make the United States more energy independent, it's a strong assumption of mine that drilling activity in the Marcellus Shale region (where Quality Distribution operates), and in nearly all natural gas fields, is bound to pick up.

For its logistics and intermodal segment I'm expecting a big rebound in 2013. Organic growth in this segment is projected to be in the high single digits and seems very feasible considering that unusually high repair and health costs should abate next year, and more stable fuel pricing should give trucking and logistics providers better pricing power.

In chemicals, organic growth is expected to remain in the mid-single digits, and should benefit almost immediately from the company's choice to switch logistics terminals from a financially and operationally troubled affiliate to a new affiliate devoid of these problems.

To me, it appears that this quarter was full of one-time and unusual costs and has clouded investors' minds with fear right when every segment appears ready to turn higher. With a $15 million share repurchase in place and a forward P/E of just seven, I like what I see!

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Stocks Mentioned

Chesapeake Energy Corporation Stock Quote
Chesapeake Energy Corporation
CHKA.Q
E. I. du Pont de Nemours and Company Stock Quote
E. I. du Pont de Nemours and Company
DD
FedEx Corporation Stock Quote
FedEx Corporation
FDX
$240.47 (-1.14%) $-2.77
Werner Enterprises, Inc. Stock Quote
Werner Enterprises, Inc.
WERN
$38.94 (1.78%) $0.68

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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