KNX - Daseke Has A Good Upside Potential

Summary

• The company’s revenue should benefit from the healthy demand in high-security cargo, aerospace, agriculture, and renewables.
• DSKE’s transformational program should continue to benefit the operating ratio and help generate free cash flow to deleverage its balance sheet.
• The stock is currently trading at a lower valuation compared to its peers.

Investment Thesis

Daseke’s ( DSKE ) diversified end markets along with a presence in certain niche markets like aerospace, high-security cargo, and renewable energy should help it do well despite the weakening macroeconomic environment. The company’s transformation program which focuses on reducing costs and eliminating inefficiencies is helping improve its adjusted operating ratio and generate healthy free cash flow. DSKE is paying down its debt from the cash flow generated and has brought down its net leverage to 1.9x at the end of Q1 FY23. Given the good growth prospects, low valuations, and the company’s focus on deleveraging its balance sheet, I have a buy rating on the stock.

Revenue Drivers and Outlook

Daseke’s presence in several end markets, some with high cyclicality and others with non-cyclical tendencies, provides a highly diversified customer portfolio. The company is seeing healthy demand in some of its end markets, including high-security cargo, aerospace, manufacturing, construction, and agriculture. However, it is experiencing declining demand for the transportation of steel, lumber, and other building materials due to the weakening residential market. The good news is the residential market contributes only 5-6% to the overall revenue and the growth in the rest of the business can easily offset a slowdown in this market.

On the pricing front, it is a mixed bag. In the specialized solutions segment, the demand remains strong, which leads to a sequential increase in the rate per mile in the last reported quarter. However, in the flatbed segment, the rate per mile declined sequentially due to the weakness in the residential as well as other markets.

Looking forward, the strength in the aerospace and high-security cargo, renewables, and agriculture business should continue. I am particularly bullish on the prospects of aerospace and renewable with the former benefiting from a resumption in travel while the latter benefiting from the increased investments towards energy independence. On the construction side, while residential is expected to remain weak, infrastructure projects are likely to pick up as the funding from the U.S. government’s ~$1.2 trillion infrastructure spending bill starts flowing through. The company can also change the availability and configuration of equipment and deploy it to serve the markets where demand is high. I believe these capabilities should allow it to organically capture attractive freight opportunities and improve its market share with blue-chip shippers during these tough freight market conditions. Overall, I believe the company can see flat to slightly positive revenues in FY23 with a macroeconomic slowdown offset by strength in some of the company’s key end markets and market share gains.

The company’s topline may also benefit from inorganic growth in the medium to long term. The healthy pricing environment over the last 18 months, along with the company’s cost reduction program, helped generate good free cash flow, which the company utilized to pay down its debt. Approximately 50% of the cash flow generated from operations between 2020 and Q3 FY22 was used to repay debt and strengthen the balance sheet. The company’s net leverage declined from 3.3x in Q3 FY19 to 1.9x in Q3 FY22, and its target is to reach net leverage of 1.5x. Once it reaches this target, the company plans to start a dividend program and restart its M&A program focusing on small tuck-in acquisitions.

Margin Outlook

The company’s adjusted operating ratio has improved over the past few years due to its transformation efforts, which began in 2019. However, in 2022 the adjusted operating ratio increased slightly due to the increase in salaries, wages & benefits as a percentage of revenue, insurance claims, and purchase transportation costs. This was partially offset by the company’s transformation efforts.

Under the transformation program, the company focuses on reducing costs and eliminating inefficiencies by identifying under-utilized assets. This led to a reduction in company-owned trucks and trailers as well as non-driver staff. The company is continuing to work on its transformation plan, which is critical in laying the groundwork for the optimization phase which will begin in 2024. DSKE is using technology across its operating companies to reduce its fixed costs and eliminate some of its variable costs. The transformation phase is expected to be completed by the end of 2023, with $25 mn in cost savings.

Looking forward, I believe the continued progress on the transformation program should help improve the adjusted operating ratio in 2023 and beyond. Additionally, the company’s diversified end markets and exposure to some of the end markets which still remains strong should result in flattish to slightly positive volumes. So, the company is better placed than some of its more cyclical peers to maintain and grow margins in the near term.

Valuation & Conclusion

The stock is currently trading at a forward EV/EBITDA of 3.81x , which is at a significant discount to its peers’ forward EV/EBITDA.

The company should benefit from the healthy demand in high-cargo security, aerospace, manufacturing, and agriculture, which should offset the softening demand in residential as well as other markets. DSKE’s transformation efforts should help improve margins and reduce its net leverage over the next few years. Given the good growth prospects and cheap valuations, I have a buy rating on the stock.

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