Analysis: takeover bid for XPO Logistics just a matter of time – and share price
The reason why I have not downgraded my personal fair value (FV) estimates of US-based ...
Ryder Systems is pushing hard to grow its business, which comprises fleet management and supply chain solutions (FMS and SCS), with combined revenue of $6.6bn in 2014, as quarterly and annual results showed yesterday.
Yet Ryder Systems must deliver on its promises, and grow at a faster clip for its stock to rally from its current level of $88.5.
The group, a US-based supply chain solutions provider, forecasts full-year 2015 comparable earnings from continuing operations to be in the range of $6.25 to $6.40 per diluted share, up 12% to 15% from $5.58 per diluted share in 2014. Is that good enough? Read on.
FMS 4Q revenues (excluding fuel) stood at $930.8m, up 6% compared with the year-earlier period. Growth was partially offset “by the impact of lower fuel prices,” Ryder said, adding that full service lease revenue increased 5% due to higher prices on replacement vehicles and growth in the fleet size.
“The number of full service lease vehicles (excluding U.K. trailers) increased by 3,200 from the year-earlier period and grew by 2,200 vehicles sequentially from the third quarter of 2014,” Ryder also pointed out (here it gets a bit more exciting…), while “commercial rental revenue improved 10% reflecting increased demand and higher pricing in North America.” Fuel services revenues, meanwhile, decreased 15%, primarily reflecting lower fuel prices passed through to customers, it added.
FMS earnings before tax were $122.5m in 4Q, up 25% year-on-year. Rental power fleet utilisation was marginally higher at 80.1%, on a 7% larger average fleet.
“Full service lease results benefited from lower depreciation associated with increased residual values and growth in the fleet size,” Ryder concluded.
Moving on to SCS, the smaller unit reported 4Q revenue (excluding subcontracted transportation) of $546.3m, up 4% year-on-year. SCS operating revenues grew as a result of new business and increased volumes, partially offset by automotive business lost earlier in the year, lower fuel costs passed through to customers, and the negative impact of foreign exchange, Ryder said.
It doesn’t look great, does it?
SCS earnings before tax of $33.7m increased 2% “due to new business and higher volumes,” the company added. “These improvements were partially offset by higher insurance costs”. In short, SCS is not living up to expectations, and management must know that.
“With the change in leadership in our logistics business this year, we’ve going to start reporting three business segments. While there is no change in the FMS reporting, we’ll report our Supply Chain and Dedicated activity separately starting in the first quarter,” Robert Sanchez, chairman and CEO of Ryder, told analysts, where management noted that SCS operating revenue is expected to grow at a modest 2% in 2015, and that growth will be “partially offset by volume declines and network redesigns with some current customers.”
Management expects “revenue growth in Dedicated up 10% reflecting strong new sales activity,” however.
John Mims of FBR Capital Markets wasn’t shy to ask about the most important topic, namely: lease fleet guidance: “Last year you had guided to about 2000 trucks in growth and ended up being 3,200. You know the guidance this year is obviously much stronger than that, but based on that 4000-truck number, what do you know right now, like how sticky is that number now as far as what’s committed? What kind of sensitivity there may be to the upside or also to the downside of that 4000-truck growth?”
Mr Sanchez replied: “Yeah, we feel really good about the 4000, a lot of that is driven by what we saw in the fourth quarter.” He added: “We had a record sales quarter in the fourth quarter. So that’s going to give us a nice boost going into 2015.”
“As you saw we ended the year strong too with the 3,200 coming in. So, if you think back, we’ve been talking about this for several years, right? That we believe that Ryder can become a growth company and a growth story primarily because, there are two reasons. One is the economy improves and the second thing is that there are trends that really favor outsourcing and the things that we do continue to get tougher because of regulation, because of more complexities around technology.”
What’s going on?
Ryder is investing and is using debt, and lots of it, to fund its ambitious growth plans. Whether a strategy based on owning lots of trucks and leasing them out to haulage companies and freight forwarders will work hinges on easy access to capital, as well as how such a strategy is funded.
Ryder announced earlier this week it had secured a $1.2bn revolver, an undrawn credit facility that amends and increases by $300m its exiting core credit line. In doing so, it profits from loose market conditions for credit, likely knocking off several basis points from its cost of funding, while pushing back maturity to 2020 from 2018.
Ryder has $4.6bn of total debt outstanding, and that’s reflected in its enterprise value, which doubles Ryder’s market cap of $4.6bn, yielding an implied forward net leverage of about 2.8x in 2014. Debt is manageable for the time being, or at least until Ryder runs fast and doesn’t lose key customers.
“Year-end leverage was above our earlier expectations due to a year end pension equity adjustment,” Art Garcia, Ryder’s CFO, said on the call following the results.
The successful refinancing round signals confidence in the business and a willingness by lenders to fund its ambitious expansion plans – 12 global banks made up the syndicate backing the deal. Incidentally, the spread between the average price target from brokers and the stock price (+27%) has widened from $4 to $18 in the last 12 months, which means investors believe analysts may have to tweak down their forecasts.
What investors think about the business and its prospects is just as important as trying to determine whether the business itself is on a sustainable growth pattern. To answer that, Ryder’s track record helps a lot. Between 2011 and 2014, revenue have grown a tad above US inflation, but comparable profits from continuing operations have risen at a much faster clip, recording a three-year compound annual growth rate of about 19%, which is a truly impressive performance.
And although “Ryder’s full-year 2014 earnings from continuing operations were $220.5m, down 9% compared with $243.2m in the prior year,” as the company said, that came in the wake of unrecognized actuarial losses, and is a non-cash charge that should be excluded from comparable earnings. The most important element to monitor is cash flow, however. The group will need to grow earnings at a faster pace while properly managing working capital if it’s ever to do any better than reaching break-even for free cash flow in the next few years. In 2014, it burned just less than half a million a day.
“Free cash flow from continuing operations in 2014 was negative $202m and better than expected due to timing of cash payments, compared with negative $386m for the same period of 2013,” Ryder said yesterday. Dividends (projected yield at 1.5%) and earnings per share are on their way up, but net leverage is also rising — debt is used to fund the payout — and forces management to push at full throttle for expansion, banking on bullish growth assumptions.
While the average price target from brokers has steadily risen in the last twelve months (+41%, to $106 from $75), and in spite of a 5% rise on Tuesday, Ryder shares still trade at $88.5, i.e. some 7% below the high they recorded on 28 November. Trading multiples and fundamentals indicate a fair value of $75/$80 a share, in our view.
By comparison, the S&P 500 is flat over the period, which is not unusual given that Ryder is a high-beta stock. The shares, however, have traded in the $80-$95 corridor for 10 months now, and have been volatile since early September 18. Why so?
When risk-off trades prevail, investor must preserve returns, and Ryder becomes a less obvious investment. Moreover, investors know that growth will be harder to achieve in the next few quarters, while a higher growth rate may require greater heavy investment than in the past, which, in turn, may dilute returns. Capex is at a record level of $2.3bn annually.
Perhaps there’s nothing to worry about right now, but if things do not work according to bullish forecast for growth, then a dividend cut or smaller buybacks or even a cash call – or a combination of the three – may ensue.
Mr Sanchez noted that the group’s “return on capital spread and return on equity are expected to reach record levels in 2015”, but additional basis points contribution was minimal in 2014, as the spread between adjusted return on capital and weighted average cost of capital rose to 110 basis points from 100 basis points one year earlier.