USX - Knight-Swift Transportation: Adding To The Dealmaking Track Record

2023-03-21 18:37:11 ET

Summary

• Knight-Swift Transportation Holdings Inc. has seen 2022 end on a softer note.
• The margin profile from 2021 and early 2022 was not sustainable, with 2023 earnings set to fall a bit.
• Despite earnings falling as much as a dollar per share, shares trade at just 14 times earnings here.
• A modest leverage ratio and potentially lucrative deal make the situation still interesting for the long haul.

In January of last year, I concluded that further M&A was the driver behind more growth in the case of Knight-Swift Transportation Holdings Inc. ( KNX ) . The company used cash flows generated following a strong 2021 to pursue some deals, as low earnings multiples were not automatically compelling as margins did not appear sustainable.

A Look Back

The story behind Knight-Swift goes back to 2017, when the much smaller Knight Transportation acquired Swift, possibly because Knight looked to impose the same discipline to Swift as was applied to their own business, and financing and equity markets were generous at the time. After all, Knight was just a $1.1 billion business, although it posted operating margins in the mid-double-digit territory, while Swift generated about $4 billion in sales, although just accompanied by margins of around 7%.

Synergies were pegged at $150 million by 2019 as realization of these could boost earning power from $1.30 to $1.85 per share, as the market welcomed the deal, with shares rallying to $35 at the time. Shares even rallied to the $50 mark in 2018 as the company was set to post earnings of around $2 per share, while net debt was largely equal to reported EBITDA.

While the $50 mark was a bit too rich for me, I got involved at $35 in 2019 as the company posted sales of $5.3 billion for 2018, posting net earnings of $2.36 per share in the process, as these results were strong. The 2019 performance was soft, with sales down to $4.84 billion, and earnings down to $1.80 per share, as the business faced intense competition and softer demand, although net debt fell towards the half-a-billion mark.

Revenues fell another 3% to $4.67 billion in the pandemic year 2020, although margins rose sharply, with adjusted earnings posted at $2.73 per share, all while net debt was cut further to $300 million. The company called for 2021 earnings to rise to a midpoint of $3.30 per share, as the $40 valuation at the time looked like most.

Amidst the recovery in 2021, the company acquired AAA Cooper Transportation that summer in a deal adding $780 million in revenues, with the deal coming in at $1.35 billion price tag. While net debt rose to $1.35 billion, this was equal to just about the EBITDA run rate, as the company guided for earnings to rise to the $4.50 per share mark. This pushed shares up to $58 per share early in 2022, valuing equity at $9.7 billion and the enterprise valuation at $11 billion. This was applied to a business generating $5.7 billion in sales, valued at just under 2 times sales and about 7 times EBITDA.

Knight furthermore announced another $150 million purchase of Midwest Motor Express before the end of the year, adding to the track record and momentum. Based on $4.50 per share in earnings power, the 13 times earnings multiple looked reasonable amidst modest leverage, yet earnings were likely not sustainable as margins came in quite a bit above their long-term average. Amidst this, I felt no need to change my position, although I was happy to continue to hold onto my long position.

Stagnation - Coming To Life

Since early 2022, shares have not moved at all on a net basis, currently trading at $57 per share, after shares have traded in a $45-$60 range over the past year.

Early in 2022, it turned out that Knight-Swift grew 2022 sales to $6.0 billion following a strong fourth quarter as the company posted net earnings at $743 million, equal to $4.45 per share. Given the continued dealmaking, the company guided for continued earnings growth in 2022, with adjusted earnings seen between $5.10 and $5.30 per share.

Fast forwarding a year, we see that the company has seen a reasonable 2022, amidst challenging economic conditions. Full year sales rose to $7.4 billion, aided by fuel surcharges, which doubled to nearly a billion. Full year operating earnings rose to $1.09 billion as higher interest expenses and some other charges made that net earnings only rose to $771 million, equal to $4.75 per share as adjusted earnings of $5.03 per share fell a bit short to expectations.

This was due to weakness in the fourth quarter, a period in which adjusted earnings fell to just a dollar with revenues down year-over-year to $1.74 billion, trending at around $7 billion. Net debt fell just below the billion mark, while EBITDA trended around $1.6 billion.

The company offered a very cautious guidance for 2023 with adjusted earnings seen between $4.05 and $4.25 per share, mostly the result of general cost inflation and the fact that rates are seen down in the mid-to-high-single digits.

The company has reduced the share count to 162 million shares which reduces the equity value to $9.2 billion here, and the enterprise valuation just over $10 billion, actually down about 10% from early 2022, even as shares traded at the same levels.

A Big Deal

Amidst the turmoil in the (regional) banking sector, Knight-Swift has announced a deal to acquire U.S. Xpress Enterprises, Inc. ( USX ) in a deal valued at $808 million, that is on an enterprise basis. This is equal to about 8% of the own enterprise valuation, but the deal will grow sales by about 30%, as U.S. Xpress generated about $2.2 billion in sales, yet the lower sale multiple comes as the business faced real margin challenges (that is an understatement).

The deal calls for a huge premium at $6.15 per share (with shares of U.S. Xpress trading up 300% in response to the deal), yet Knight believes that it too can generate operating margins in the mid-double-digits over time, revealing that a very low earning multiple is paid if this can be (even partially) achieved.

The company indicates that earnings per share accretion is seen from 2024 onwards, but unfortunately, it has not specified this. In the near term, we likely see some dilution with the business posting a $27 million operating loss in 2022, as these losses and incurred interest costs will likely weigh on earnings.

If Knight can really add about $300 million in operating earnings with the deal, the company will make a killing and could easily boost earnings by a dollar, while leverage remains intact. It is this low sales multiple which makes investors upbeat, with shares of Knight up 7% in response to the deal, adding more than half a billion to its valuation in response to the deal.

And Now?

Truth is that the standalone earnings power in 2023 was set to soften, but I fully expected this early in 2022. A $56, Knight-Swift Transportation Holdings Inc. trades at 14 times earnings, as the mid-term thesis will be bolstered by the deal for U.S. Xpress, although that real execution is needed to drive accretion.

That said, overall valuations are non-demanding, as leverage is very controllable as well, making me a continued holder of Knight-Swift Transportation Holdings Inc. stock here, looking for the next run higher going forward with the business on track to break the $10 billion sales mark soon.

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