With its focus on predictable freight lanes, diligent cost-control and sizeable economies of scale, the company achieves high utilization rates and solid operating margins over the cycles. Conversely, this network effect coupled with an established reputation allow for competitive pricing packages, in effect keeping smaller competitors at bay on big-volume contracts.
But shipments come of all sizes, and not all customers are as prodigal as Wal Mart's — Knight-Swift's largest customer, accounting for 15% of revenue. Because it is still too fragmented, the U.S. has long remained a difficult market. Too many operators are out there on the roads, competing for any business they can get regardless of profitability — especially in the less-than-truckload segment.
Survival at the expense of bottom line has been the defining paradigm for most mid-sized carriers. M&A is a way to eliminate these troublemakers but low barriers to entry mean that new ones emerge on a steady basis. Fortunately, after several rounds of consolidation, this is starting to change.
The largest carriers now own massive fleets and virtually non-replicable infrastructures, with hubs and service centers integrated across the continent. Such scale comes at a cost that few can afford. Knight-Swift belongs to that group of select few. In the future, the gap between those and mid-sized carriers should widen even further.
Unlike some of its peers, the company acknowledges that adding scale is not always the best answer in the truckload business. On the contrary, the ability to dump barely profitable lanes when decent return on investment thresholds cannot be realized is what separates the best operators from the pack. Albeit logical, such discipline is easier advertised than practiced.
Securing good driver retention is another challenge. Everyone struggles on that front, with industry-wide turnover rates sometimes as high as 20% and widespread labour shortages. Offering high wages tames the issue but requires that lasting cost efficiencies can be pulled off at other levels of the cost structure — hence the strategic importance of scale.
Fortunately, Knight-Swift's management is proficient at that. The integration of Swift — the current company results from the merger of Knight Transportation and Swift Transportation in 2017 — has been successful and frictionless, even though Swift was severely lagging behind with respect to operating metrics.
If Knight's low-cost blueprint has worked there, it will also work elsewhere. The recent acquisition of AAA Cooper comes to mind. With 3,000 tractors, 7,000 trailers and 70 service centers covering the dynamic South-Eastern markets, the newcomer represents a valuable addition to Knight-Swift's national footprint.
Valuation-wise, the €1.35bn transaction gave AAA Cooper a price tag of x1.7 revenue and x10 EBITDA. Compare this with Knight-Swift's current valuation metrics of x1.5 revenue and x7 EBITDA. One would expect that investors factor in a premium for scale — especially when the company sports such a sterling balance sheet — instead of a discount. So what gives?
The main reasons are that capital expenditures and bolt-on acquisitions typically eat up all free cash-flow, leaving only crumbs for dividends or share buybacks. Meanwhile, operating leverage is as maximal as it can get and growth prospects are capped. It's a peaking trucking market where each big player defends his share of the pie. Absent acquisitions, there's no way to break through.
Price-conscious acquirers like TFI International — led by distinguished CEO Alain Bédard — are used to paying x5 to x7 EBITDA when they go shopping for peers. This is putting a floor under established players' fair values. Assuming that it would entertain the idea of a sale, an operator as strategic and efficient as Knight-Swift would most likely command a serious premium.
As the fifth largest carrier in the U.S., the company could be a target of choice for other industry leaders. Barring any adverse development, and given its remarkable financial standing, it's hard to see it getting swallowed for less than x10 EBITDA — i.e between $75 and $100 per share depending on the operating variables modeled in.
We should know soon. M&A typically picks up when bad news surface — and bad news surface often in the trucking business. Intensified regulatory overwatch due to greenhouse emissions control, exposure to rising oil prices, chronic labor shortages and a strong dependence upon the general health of the economy can all impact business quite dramatically.
The good news is that volumes keep growing — a trend that shows no signs of abating in the age of e-commerce. Taken with all the factors listed above, this warrants Knight-Swift's top ranking on MarketScreener's quantitative ratings.