SAIA - Saia Should Emerge Stronger On The Other Side Of The Cycle

Summary

• The company’s revenue and margin in the near term should be impacted due to the decline in volume growth and inflationary cost pressure.
• The strategic initiative of opening new terminals should help improve the company’s service quality level, benefiting long-term growth.
• In the long run, margins should benefit from the productivity gains in its business, reduction in purchase transportation costs, and improvement in volume growth.

Investment Thesis

Saia, Inc. ( SAIA ) is seeing declining volumes over the past few months due to weakening consumer demand. The company’s revenue and margin in the near term should be impacted due to the decline in volume growth and inflationary cost pressure, partially offset by the pricing actions. However, I believe the long-term prospects for the company remain strong due to the opening of new terminals, which should improve its service quality levels and help the company charge more for its services. SAIA is also driving productivity gains in its business and is working to reduce purchase transportation costs which should benefit the margins in the long term. The stock is trading at a significant discount to historical levels. Given the good long-term growth prospects and low valuation, I have a buy rating on the stock.

Revenue Outlook

The recovery in demand post-covid outbreak has benefited the company until the first half of 2022. The company started experiencing moderation in demand in Q3 2022 which impacted volume growth. The shipments per workday declined 2.5% Y/Y and 4.8% sequentially in the third quarter. This was offset by price increases implemented by the company, resulting in positive sales growth. The LTL revenue per shipment (excluding fuel surcharges) increased 10.2% Y/Y to $282.4 due to positive pricing and effective mix management. The LTL yield or revenue per hundredweight (excluding fuel surcharges) increased 7.8% Y/Y to $19.74, reflecting a constructive pricing backdrop.

The declining trend in volume growth continued in the month of October and became worse in November. In October 2022, the LTL shipments declined 4.4% Y/Y and the tonnage per workday declined 3% Y/Y. In November, LTL shipments per workday declined 8.6% Y/Y, and the LTL tonnage per workday declined 7.7% Y/Y.

Looking forward, I believe the volume decline should continue in 2023, impacting revenue growth in the near term. The end-market demand is declining, especially on the retail side of the business. However, this decline should be partially offset by pricing actions. The company has yet to announce its General Rate Increase (GRI) for 2023. It usually announces it in January. One of SAIA’s competitors, Old Dominion Freight Line ( ODFL ), announced GRI of 4.9% in December. I am expecting a similar General Rate Increase by SAIA as well.

The company plans to continue to work on its long-term strategy of improving service by opening new terminals, despite the weakening macroeconomic environment. Each new terminal opening brings it closer to the customer and adds value to the supply chain resulting in market share gain and better pricing power. In the third quarter of 2022, the company achieved its guidance of opening 10 to 15 terminals in 2022 by opening 11 terminals in the first nine months of 2022. The company is aiming to open 10 to 15 new terminals in 2023 and relocate 10 terminals. While the pipeline for new terminal openings extends well into 2025, the company can adjust the pace of the openings given its strong balance sheet. The company is exposed to business cyclicality and depending upon its position in the cycle and management’s priorities, it can accelerate or slow its terminal expansion activity. The addition of new terminals should help the company gain market share in both new and existing markets in the long term. It should also help increase prices based on a higher quality of service to its customers (value-based price increases.)

Despite good price hike prospects, I am not optimistic about the company’s sales outlook. I believe the decline in volumes (which are currently trending down high single digits) should more than offset the price hikes, resulting in a sales decline in the near term. However, the long-term prospects for the company remain healthy given its strategic initiative to improve service levels and supply chain efficiency by opening new terminals. This should help the company gain market share in both new and existing markets along with implementing value-based price increases. I expect SAIA to emerge much stronger on the other side of this cyclical slowdown.

Margin Outlook

Over the last couple of years, the company’s operating ratio improved due to price increases as well as a favorable mix. However, in Q3 2022, the operating ratio decreased sequentially due to the increase in depreciation expenses from the onboarding of new tractors and trailers and the increase in salaries, wages, and benefits.

Looking forward, I believe the company’s operating ratio should be impacted in the near term due to volume deleverage and inflationary cost pressure. However, I believe it should improve in the long run. The company should partially offset near-term cost headwinds through its annual GRI. In the long term, the operating ratio should benefit from productivity gains and a reduction in purchase transportation costs. The company aims to achieve productivity gains through the use of technology and the efficient handling of freight with the right tools to reduce the number of claims. Additionally, the Purchase Transportation costs should come down over time as the company is working to leverage the internal assets and driver network.

I am optimistic about the company’s long-term margin prospects as it continues to improve its service levels and implement value-based pricing to benefit from that improvement. ODFL, another LTL company, which is known for its high-quality service and charges premium pricing, has an operating ratio in the high 60s - low 70s range . So, clearly, there is a lot of upside still left in terms of margin expansion if SAIA follows a similar strategy and executes well.

Valuation & Conclusion

The stock is currently trading at 16.49x the FY23 consensus EPS estimate of $12.71, which is significantly lower than its five-year average forward P/E of 22.67x. The company’s revenue and margin in the near term should be impacted due to the decline in volume growth and inflationary cost pressure. However, I believe the long-term prospects for the company remain strong due to the opening of new terminals, which should improve its service quality levels. This should help the company charge more for its services. SAIA is also driving productivity gains in its business and is working to reduce Purchase Transportation costs, benefiting the margins in the long term. Given the good long-term growth prospects and lower than historical valuation, I have a buy rating on the stock.

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