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FINE FIFTEEN: OUR TOP PICKS FOR 2009
Key Points
• Introducing the “Fine Fifteen.” In this report, we outline our “Fine Fifteen” ideas for
2009 and provide one honorable mention micro-cap idea. In this report we provide a
detailed investment thesis for each of these names. It is important to note that while we have
a few other Buy (1)–rated names in our universe beyond our “Fine Fifteen,” we have the
greatest conviction in these ideas and believe the risk to these companies’ earnings and cash
flow estimates is less than our broader coverage universe. While we believe the risk to
numbers is less for these names, we note that visibility into 2009 is spotty at best and
another stair-step function down in volumes could result in meaningful changes to our
outlook and estimates. We point out to investors that this is a living, breathing list of our top
ideas that will change during the year as price targets are reached, outlooks change, or
unforeseen catalysts emerge. Our intention is to revise this document quarterly, updating
our thesis on our top ideas and adding and subtracting names as necessary.
• Airfreight & Logistics. The airfreight and logistics group is likely to see a major
divergence in fortune and results in 2009, based largely on asset intensity versus non-asset
based business models. On the airfreight side, volumes will likely be under pressure both
domestically and internationally. In terms of the logistics names, we continue to believe
that non-asset based business models should thrive in the current environment, especially in
comparison to their asset-intensive peers. We believe that two catalysts exist for these
names: (1) excess capacity from the asset-intensive carriers and (2) saleable business
models. In general, we believe there will be less earnings risk for these companies, especially
in early 2009.
• Inland Barging. We believe 2009 will be another solid year for inland barging stocks.
Though the economy has slowed over the past year, we remain confident that industry
fundamentals should hold strong on the liquid side of the business and are poised to
strengthen on the dry side. Our bullish thesis on liquid barging remains based on strong
pricing, which should drive EPS absent volume growth. Our outlook for the dry barge
operators is markedly better for 2009 than it has been for the past 18 months. After nearly
two years of weak volumes and therefore weak pricing, we believe that fundamentals are
shaping up to improve over the coming year.
• Railroads. We believe 2009 will be another profitable year for the railroad industry, with
EPS growth driven by strong pricing even in the face of another year of volume declines. All
in, we are forecasting SSS-type pricing increases of 4%–6% for the entire industry.
• TL & LTL. While we anticipate stiff near-term headwinds for the group, we remind
investors that the truckload and less-than-truckload sectors tend to be early cyclical plays.
Even though we have recently lowered our EPS estimates for most of the TL names within
our coverage universe, it has been common knowledge for some time that Q4’08 is likely to
be a rather dismal quarter for the carriers within our coverage universe as the macro
economy has taken another step down.
• Transportation Suppliers. Basically, we don’t see material capex spending coming from
either the TL or LTL carriers in 2009, and most of the carriers we have spoken with aren’t
planning to buy trucks beyond normal replacement levels, much less purchase new trailers.
All in, we expect to see a very soft truck equipment market in the beginning of 2009. Even
though demand for railcars will likely remain weak, we still project 40,000 railcars to be
delivered in 2009, a far reach from the last downturn, which yielded less than 18,000 new
railcar deliveries in 2002. We believe these are adequate numbers and should enable most
railcar manufacturers to sustain production levels, albeit significantly reduced from 2006.
THE FINE FIFTEEN: OUR TOP PICKS FOR 2009
Happy New Year! We believe most of you couldn’t wait for 2008 to come to a close, taking
with it the market volatility and worsening economic backdrop that unfolded in the last five
months of the year. However, before we take a closer look at 2009, we believe it is necessary
to inflict pain one last time and recall all the joys experienced by our airfreight and surface
transportation coverage universe over the past 12 months. This conversation can start with
only one topic: fuel prices. During 2008, the companies in our coverage universe experienced
a sharp (that’s putting it mildly) increase in fuel prices (be it diesel fuel, bunker fuel, jet fuel,
etc.) that proved more difficult to overcome that anyone could have imagined. As a result,
these companies experienced material downward pressure on margins and profitability as fuel
surcharge mechanisms proved slow to recover the higher fuel cost, and oil/fuel prices
increased so rapidly that hedging became a virtually impossible task. As a result, profitability
took a beating through the first seven to eight months of 2008 and resulted in an exodus of
capacity from nearly every mode of transportation we follow. Furthermore, the lower-cost
transportation alternatives, namely rail, barge, ocean, and ground-oriented airfreight
operations, gained market share from the TL, LTL, and traditional airfreight providers as a
result of the surge in fuel prices and the associated surcharges. However, an interesting thing
happened in the last few months of the year: fuel prices collapsed, resulting in much betterthan-
expected results for the more fuel-sensitive companies, such as the aforementioned TL
and LTL sectors, and we’ve seen another shift in market share as a result. While fuel is always
an unknown variable and has proven difficult to predict, we believe that it should be a
tailwind for the majority of the companies in our coverage universe for at least the first two
quarters of 2009.
While fuel dictated much of the discussion, the economy certainly ran a close second. For the
first seven to eight months of 2008, the U.S. economy kind of meandered along with volume
declines (either based on tonnage or miles) down in the low-single-digit range. However, with
the onset of the credit crisis following Labor Day and the associated market volatility, freight
volumes cratered and demand for transportation/supply chain services plummeted along with
it. As expected, the weak demand environment has begun to put downward pressure on
pricing across nearly all modes of transportation as weaker players struggle to survive and
shippers see an opportunity to reclaim the dominant position in rate negotiations in most
industries. Furthermore, the decline in fuel costs and the associated decline in fuel surcharge
collection will likely result in some pricing degradation as well. While pricing in all modes is
under pressure, we believe that certain sectors are likely to be more affected than others. On
one end of the spectrum, both the TL and LTL sectors will likely experience a sharp decline in
rates, at least in H1’09, as there remains too much trucking capacity chasing too little freight
and weaker players (both small mom and pops and large publicly traded carriers) struggle to
survive and maintain current market shares. On the other end of the spectrum, we believe the
railroad sector will continue to enjoy better-than-historical pricing gains as a result of the
large (albeit smaller than a couple of years ago) percentage of legacy contracts left to reprice
up to current rates. We remind investors that these are 15- to 20-year-old contracts, which
haven’t repriced since originally negotiated, that are seeing rate increases of anywhere from
60% to 100%. While the weaker economic backdrop likely to be experienced in 2009 could
take some of the steam out of these renegotiations, we believe that robust increases are still
likely and that core rates for the entire book of business for the U.S. Class 1 rails will increase
4%–6% during 2009. The other modes will likely fall somewhere in the middle, although
landscape-changing events may influence rates more materially than expected throughout
2009. For example, recall that DHL has decided to exit the U.S. domestic parcel market in
early 2009. As a result, UPS and FDX will likely split the majority of DHL’s market share,
possibly resulting in firmer pricing. However, given the magnitude of the economic slowdown
and the shift of freight from the air to the ground, rate increases may not materialize until a
meaningful recovery in the U.S. and international economies begins. It appears that Q4’08
earnings season is going to be one for the ages with a precipitous decline in volumes, weaker
pricing and margin pressure resulting in weak earnings results, and what is almost certain to
be a pessimistic forecast for 2009. The trucking industry is another sector where landscapechanging
events may result in firmer pricing. It is no secret that a number of carriers,
including three well-known larger players in both the TL and LTL sectors, are struggling. If
one or more of these carriers exited the market, we believe the remaining players would get
much healthier much quicker with volumes not being an issue despite a weak economy. We
also see an immediate firming in rates but believe rates could surge even higher as the
economy recovers and TL and LTL capacity becomes very tight.
Finally, we briefly examine the credit crisis and the impact it has had on our coverage
universe. For the most part, the companies within our coverage universe haven’t been
impacted by this issue. There have been no government-engineered bailouts and no
liquidations or bankruptcies (yet) as a result of credit issues. The majority of our universe
enjoys healthier balance sheets than in past cycles with net debt-free balance sheets not
uncommon. Furthermore, we haven’t seen a sector or industry-wide suspension of share
repurchases or dividend cuts. For the most part, these companies have continued to operate
as normal with a sharper eye on cost containment, capital allocation, and free cash flow
generation; as a result, credit availability isn’t likely a worry. However, as with all things in
life, there are exceptions. For example, both YRCW and ACLI are experiencing a difficult
operating environment and struggling with covenant violations or worse yet, the need to
refinance existing debt with a new credit facility. YRCW recently announced that it is in
negotiations with its bank group for a waiver to certain debt covenants by the end of January
and has cancelled its planned tender offer for outstanding debt. We believe this bodes poorly
for the company and may be the result of a more skittish bank group not wanting to lend any
more money to a company experiencing 20% plus tonnage declines and continued
unprofitable operations. In ACLI’s case, it has a credit facility that expires at the end of Q1’09
and as of yet hasn’t negotiated a new facility. We believe that ultimately the company will get
a new facility, but we’re concerned that the new facility will cost significantly more than the
existing one and will provide ACLI with little financial flexibility, especially if the U.S.
economy gets any worse. In general, credit availability hasn’t been an issue for our coverage
universe but in the instances where it has occurred, the consequences are serious.
All in, these three “fun” topics will likely rear their heads again in the future. We believe that
the economy is by far the most important issue as we go into 2009 with credit pulling in as a
close second, followed by fuel. We also worry a little about additional regulation imposed by
the new Congress and administration but believe that some the current economic challenges
may keep these issues pocketed in the near term.
Now that our 2008 recap is completed, let’s take a look at 2009. Below we provide a brief
outlook for each sector we cover within our airfreight and surface transportation universe. In
terms of the macro outlook, we are looking for a material recession with continued pressure
on volume and demand for transportation/supply chain services. We also believe that the
weak demand environment will pressure pricing and rates will deteriorate across most
sectors. Furthermore, we believe that only modest margin degradation is likely as fuel will
provide a significant tailwind at least through H1’09 and most companies we follow are
announcing or have announced major restructuring plans as a means of cutting/containing
costs and protecting profitability. We believe these efforts will allow most of these companies
to manage more efficient networks and prepare for the surge in volumes that normally
accompanies a recovery in the U.S. and global economies.
Inland Barging 2009 Outlook
We believe 2009 will be another solid year for inland barging stocks. Though the economy
has slowed over the past year, we remain confident that industry fundamentals should hold
strong on the liquid side of the business and are poised to strengthen on the dry side. Our
bullish thesis on liquid barging remains based on strong pricing, which should drive EPS
absent of volume growth. Over past few years, liquid barging rates have soared as rising
demand far outpaced growth in the industry fleet. While demand is clearly slowing as many
large chemical producers have announced that they are (or will be) slowing production
materially or closing some facilities entirely, we believe that the barge operators that have
locked in revenue through charters should have limited downside as a result of slowing
demand. Our outlook for the dry barge operators is markedly better for 2009 than it has been
for the past 18 months. After nearly two years of weak volumes and therefore weak pricing,
we believe that fundamentals are shaping up to improve over the coming year. There are
several events that could increase volumes over the coming year. First, with the massive
decline in the Baltic Dry Index, spreads once again favor shipping grain via the Gulf Coast.
Second, after two years of declines, our channel checks indicate that import volumes through
the New Orleans Customs District have begun to strengthen slightly over recent weeks; recall
that import activity represents important backhaul cargo for many dry barge operators. Last,
the grain harvest will likely be healthier than this past year’s was. Any increase in freight
volumes on the inland waterway would have a material impact on utilization and margins, but
we also believe rates would see an immediate benefit.
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