Ryder on the Storm
Heavy truck retail sales jackknifed from an annual rate of 554,000 at the end of happy-go-lucky 2006 to fewer than 200,000 in 2009 at the deep end of the Great Recession. Lots of shiny new trucks suddenly had less cargo to haul. And even as the economy turned, credit-strapped businesses were in no mood to invest in expensive new equipment.
But now a lot of those once-shiny trucks have accumulated half-a-million miles or so, and rising maintenance costs have become a real bottom-line drain. So is the cost of fuel, which the older tractor-trailers continue to guzzle at a 6-mile-per-gallon rate, versus as much as 8 MPG for next year’s models.
Enter Ryder Systems (NYSE: R), which can make these headaches, and the soaring cost of buying new heavy trucks go away by leasing its machines on a long-term basis, handling maintenance and perhaps even helping with fleet logistics. The value proposition Ryder offers to the customers who are increasingly outsourcing their transportation has seldom been stronger. And the same might be said about Ryder’s stock, which doesn’t look expensive even if we ignore the likelihood of significant cash flow increases in the medium term.
Ryder has been on a roll for a couple of years now as the economy recovered and demand improved. The January earnings report was no different: it showed that operating revenue rose 5 percent in 2012, while net income jumped 12 percent.
The flagship Fleet Management Solutions truck leasing unit, which accounts for nearly two-thirds of Ryder’s revenue, continued to see strong contract extension rates and added customers. Meanwhile, the revamped Supply Chain Solutions logistics unit grew just as fast, as strong demand from the booming automotive industry boosted margins.
Ryder generated $1.75 billion of cash last year, and could have afforded a much better dividend than the steadily rising one now yielding 2.1 percent. But the company spent $2.1 billion to upgrade and expand its fleet of 172, 500 trucks, tractors and trailers, an investment likely to pay off in significantly improved cash flow in the years ahead.
That’s part of the premise behind today’s upgrade of the stock to a Strong Buy (from Outperform) at Raymond James, with analyst Arthur Hatfield writing that the likely returns on Ryder’s hefty capital outlays are “justifiable and significant.”
Returns on capital and equity have improved steadily since the recovery began, though they are still not back to pre-recession levels. But they could chug past those levels in a couple of years as businesses rush to belatedly upgrade the expensively aging trucking fleet.
The average Class 8 (heaviest) truck in the US is now 6.6 years old according to ACT Research, and since these vehicles can put on more than 100,000 miles a year maintenance costs tend to rise sharply in the fifth year of service.
Meanwhile, new regulations limiting long-haul truckers’ working hours could reduce the industry’s effective capacity by 3 to 5 percent according to Raymond James, further stoking demand. The trucking industry has gone to court to block these changes, set to take effect July 1.
Despite a steady climb from $33 in mid-July to the recent high above $61, shares fetch just 12 times this year’s estimated earnings. Earnings per share are expected to increase another 13 percent next year, and that forecast may prove conservative as Ryder’s upgraded fleet pares maintenance costs and more companies decide to lease instead of buying.
The share buyback, recently suspended to afford the capital outlays, could be reinstated once cash flow turns positive next year. And at that point fleet operators will still need to keep buying the heaviest trucks at an above-average rate for the next four years just to catch on purchases deferred, according to ACT.
The main risk to this story is what Raymond James calls “the very fluid variable that is the economy,” with the potential for a significant downturn in the highly cyclical commercial rental business that so taxed Ryder the last time things soured. But that’s also a business with upside exposure to the ongoing recovery in the housing and labor markets. And since the bulk of Ryder’s revenue is domestic, it’s a solid play on the US economy’s recent outperformance relative to Europe, as well as its potential to close the still large output gap if the stars should align.
Raymond James raised it price target on the stock from $60 to $74, implying an upside of 24 percent from current levels. And if Ryder gets there a year from now just as heavy truck sales are peaking, the gains should keep on coming.
That’s a pretty decent risk/reward in an economy that’s just starting to set its sights beyond survival.
Igor Greenwald is an investment analyst with The Energy Strategist.