2023-07-26 19:45:01 ET
Summary
- Heartland Express, Inc. made two large deals last summer which transformed the business.
- Sales doubled practically overnight as margins took a beating, due to addition of lower margin activities and a slowdown in the sector.
- I am cautiously upbeat here, still taking a wait-and-see approach at this point in time.
In the summer of last year, I noted that shares of Heartland Express, Inc. ( HTLD ) were hitting the gas pedal. This came as the company has become active in dealmaking again, while overall valuations and leverage ratios looked very reasonable. All this looked quite compelling, as a lack of information on the recent deal and past poor performance were key factors which limited my enthusiasm.
While the company has digested both deals rather well, it has seen a big slowdown in the market, as Heartland Express shares have held up quite well in response to all of this, making me constructive, but a patient watcher from the sidelines.
Creating Perspective
Heartland reached a transformative $300 million deal to acquire Gordon Trucking a decade ago, adding 2,000 tractors and triple that number of trailers to its fleet to serve (consumer goods) customers like Pepsi, General Mills, and Unilever, among others. The promise of the deal, including significant tax benefits made that shares jumped by 25% to $18 per share overnight, pushing up the value of the equity of the company to $1.5 billion, with shares subsequently trading at a market multiple.
While the purchase price looked relatively appealing, certainly in the light of the prospects of (tax) synergies to be achieved, the 25% jump felt like a small overreaction.
Initially, the deal delivered on some of the promises with revenues reported at $871 million in 2014, but they have actually slipped to the $600 million mark, a dreadful performance if we factor in the continued and cumulative impact of inflation. Operating margins were stable in the low double digits, and while the company managed to buy back a tent of its shares, the overall outcome was very disappointing.
Early in 2022, the company posted its 2021 results with the company reporting sales of $607 million and operating profits of $105 million, albeit that this latter number includes $37 million in equipment sales gains. Earnings came in around a dollar per share, but that was including these (one-time) gains, although it was promising to see the company having built up a net cash position of $157 million again (equal to roughly $2 per share).
The 79 million shares traded at $15, for a $1.2 billion equity valuation, or operating asset valuation just in excess of a billion. This valued operations at 1.6 times sales and 13 times earnings, although the earnings numbers were in part aided by gains. The company used its strong balance sheet to acquire dry van truckload carrier Smith Transport in June of last year, as the $170 million deal would deplete the net cash position.
In August 2022, the company acquired the Contract Freighters non-dedicated U.S. dry van temperature-controlled business from TFI International ( TFII ) in a much larger $525 million deal, a deal set to add $575 million in sales with a 5 times EBITDA multiple paid for the activities.
With a $15 stock last year set to post earnings (in all likelihood in excess) of a dollar per share, the situation looked a bit more friendly, although leverage was apparent and there were some real questions marks on the pro forma earnings power and synergies set to be realized in connection to the deals.
Given that backdrop, I was looking for more clues about the operating performance in the quarters to come before potentially reconsidering my stance.
Trading Stagnant
Since my take last summer, in which I was upbeat, but cautious at the same time, Heartland Express, Inc. shares have largely traded range bound between $14 and $18 per share, currently trading at $16 and change.
In November, the company posted third quarter results, as the deal for Contract Freighters closed during the quarter, but it did not contribute for the entire period. This deal made that net debt came in at $399 million. The numbers were hard to read into with the deal closing during the quarter and one-time expense hitting the bottom line as well.
Fourth quarter revenues more than doubled to $354.9 million, as quarterly operating earnings of $26.2 million were lower than the market has gotten used to, in part the result of a lower $4.1 million gain on equipment sales, which is quite a recurring but nonetheless a volatile line item in the business model. Moreover, net debt already came down to $363 million, marking some real progress on that front, with GAAP EBITDA reported at $77 million for the quarterly period, for a number trending in excess of $300 million per year.
In April, Heartland posted first quarter sales of $330.9 million, a 118% increase compared to the year before as the performance felt a bit soft given that sequential revenues came down (as they actually increased for the core operations between Q4 of 2021 and Q1 of 2022). Moreover, operating earnings fell to just below $23 million even as asset gains increased to nearly $7 million, but fortunately, net debt fell to $310 million, needed with profitability coming a bit under pressure.
Debt reduction is driven by equipment sales and general deleveraging, as the integration of the two large deals is happening at a time when the market is cooling down significantly, putting pressure on rates. While the operating market will see some continued volatility, the first quarter EBITDA number of $71 million looked quite resilient, in combination with the rapid reduction in net debt.
With operating profits being flat in GAAP terms, net earnings came in lower following the assumption of net debt and the associated interest costs. First quarter earnings fell by five pennies to $0.16 per share as the doubling of the firm size has gone hand in hand with severe margin pressure.
And Now?
While the current times are volatile and uncertain, I am pleased with the progress made on the leverage front here in such a period. While the earnings power, which currently trends at just $0.65 per share, is a bit underwhelming, I am prepared to look through this.
If the company can return to 10% margins overtime on a $1.3 billion revenue base, the company should be able to rather easily post earnings in excess of a $1 per share assuming normal tax rates and interest rate costs, which might be the driver for shares to retest the $20 mark.
While the current tough times in the industry prevent this from happening soon, I am still taking a wait-and-see approach. Heartland Express, Inc. has dealt with the deal and associated leverage well, but the industry conditions have softened quite a bit.
For further details see:
Heartland Express: Slowing Down After A Dealmaking Spree