2023-07-12 23:30:07 ET
Summary
- Covenant Logistics Group, a US transportation and logistics solutions provider, has seen its share price rise by over 66% in the last 12 months despite a slowdown in the market.
- The company's strength lies in its asset-heavy segments, Expedited and Dedicated.
- While its less asset-heavy segments, Managed Freight and Warehousing, have struggled to maintain margins due to lower brokerage volumes and rates.
- Despite short-term market headwinds and potential future inconsistencies in quarterly reports, the company's long-term outlook remains positive, with a solid financial state and acquisition strategy.
Investment Rundown
Covenant Logistics Group, Inc. (CVLG) is a company that operates by providing customers and clients with transportation and logistics solutions in the United States. The company is relatively small with a market cap under $600 million but with revenues reaching above $1.2 billion in 2022. With a smaller market cap like this, it seems the company has gone somewhat unnoticed regarding coverage of the stock. Despite that, the share price has risen fast in the last 12 months up over 66% even though the market that CLVG operates in has experienced a slowdown in volumes and activity, as per the company's admission.
I think that the momentum in the share price is setting investors up with a difficult decision. On one hand, it seems that the current market headwinds are short-term and that activity will rebound, but a correction in the share price might very well happen as a result of the runup. In my view I am rather neutral on the stock right now, rating it a hold. I want to see some more strength in the industry and that will result in margin improvement for the company.
Company Segments
Within Covenant, four primary segments make up the business. These are as follows: Expedited, Dedicated, Managed Freight, and lastly Warehousing. Where the company remains strong is in its asset-heavy segments, which are Expedited and Dedicated. These two showed strength in the last quarter and not as severe losses in growth were experienced here. Instead much of the hardships were had in the company's less asset-heavy segments, the Managed Freight and Warehousing. The lower brokerage volumes and lower rates made the segments have a very tough time even maintaining margins.
The operating ratio for the two segments were both very high which indicates that CVLG is not nearly able to get enough out of them. This, to me indicates that for the coming quarters, the growth will likely depend on the results of these two. Seeing as they are rather volatile, if CVLG can better balance the results here every quarter then I view that as a reason for a higher multiple. Looking for companies in transportation that can efficiently weather through downturns in the cycle and demand are the ones you want to be invested in, right now with CVLG doesn't seem they have managed that, but could very well do in the future however.
Markets They Are In
The freight market has been a difficult one to operate in the last few months as seen in the latest report from CVLG but also other transportation companies I have looked at like Werner Enterprises ( WERN ) and TFI International (TFII). The CEO David R. Parker said the following in the last report, “The first quarter’s freight market, consisting of a combination of freight rates and volumes, has materially softened compared to a year ago and has remained soft throughout April”. I think this quote demonstrates that investing in the freight market right now is risky, but I also think that long-term this is just a bump in the road. If there wasn't an increase in shipping and transportation activity then the economy of the United States would have a lot of troubles. Just like investing in Visa ( V ) is a bet on stronger spending by consumers in the long run, the same is sort of true with CVLG. The question then arises regarding at what price are you willing to get in. For CVLG I think that is below where we are now. More quarters with difficulties could be ahead.
The rates for many of the measurements are down every year, but fuel prices are also down a fair bit compared to what June 2022 had. Looking at the second quarter for CVLG I do expect them to post better margins as fuel chargers would have been lower YoY. Seeing that reflected in the operating ratio will be key. But rates are also down YoY so I don't think Q2 FY2023 will showcase any impressive results for either the top or bottom line. But what CVLG is doing is acquiring new business to hopefully diversify their revenue streams further and hedge against times like this. The purchase of Lew Thompson & Son was funded by $45 million of cash at hand and the remaining $55 million for the deal came from new borrowings from the company's ABL credit facility.
Risks
The risks with investing in transportation companies are mainly about fuel prices and rates that the companies receive. Seeing from the picture above, the prices and rates have been quite volatile as 2022 had a lot of significant events happen over the world. The war in Ukraine caused the oil prices to spike and be volatile.
For investors in CVLG, these seem to be short-term headwinds, and the long-term remains positive. But I do think investors should be aware that future quarterly reports could show quite inconsistent results. As I talked about before, the asset-light segments posted significant margin contractions as the demand dwindled and rates remained low. But as fast as it goes down it could go equally as fast up again.
Financials
Looking at the financials of CVLG there hasn't been a dramatic change even if they purchased Lew Thompson & Son. The cash position sits at over $50 million and covers more than half of the long-term debts of $90 million. This puts CVLG in a solid position to keep up with purchasing companies without overleveraging themselves even if the market right now is difficult to navigate.
To further highlight the solid financial state that CVLG is in currently, the net debt/EBITDA ratio is 0.95 which is far below my preferred threshold of at least 3. I think that CVLG can in the coming years afford to make acquisitions like they just did and still not face any significant challenges regarding debt. This approach to growing their business could cause the share price to continue moving upward also.
Final Words
Right now I think that CVLG is trading at a pretty fair valuation comparing it to the growth it has previously had and what the coming quarters seem to hold. I don't think we will see any catalyst that would lift the valuation even higher. I don't think we are going to move much higher from here until the freight market sees stronger fundamentals.
With a p/e of around 11 on a forward basis CVLG is trading below its average multiples by at least 15%. However, I think investors are better off holding a position rather than adding more to it. Benefitting from the dividend and the buybacks the company is doing still seems appealing. As a result of this, I am rating CVLG a hold at the price points. A correction after the run-up could potentially be a good buying opportunity though.
For further details see:
Covenant Logistics: Not The Time To Get In Right Now