Arkansas Best Isn't The Best, But Is It This Bad?

By Stephen D. Simpson, CFA | January 29, 2012 AAA

Although the trucking market may not be quite as attractive as rail, it's not terrible. Tonnage is increasing at a slower rate, but is still positive and likely to continue growing so long as the economy grows. Unfortunately, Arkansas Best (Nasdaq:ABFS) seems to be making a tough decision on price versus volume, and needs to show better margins to validate the choice.

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A Disappointing Close to the Year
Of the three metrics that most transport investors place great importance on, Arkansas disappointed meaningfully on two. Revenue was up 5% in the quarter, but strong pricing (up almost 13% per hundredweight) was offset by very weak volume. Tonnage was down about 8% in the fourth quarter, and weakened as the quarter went on. Given the overall tonnage trends, it looks as though Arkansas Best may have priced itself out of some business.

Profitability was also problematic. The company's operating ratio did improve 140 basis points and was in the black, but was still pretty well shy of most analyst expectations. (There are three key profit-margin ratios: gross, operating and net profit margins. For more, see A Look At Corporate Profit Margins.)

Where's the Growth Going to come from?
Arkansas Best has excellent coverage throughout the United States - roughly 98% or so. That means that almost no business is out of reach for the company. It also means that the company has to get creative to keep growing.

The trouble with the transportation industry is that overseas growth is often a non-starter. While companies like FedEx (NYSE:FDX), UPS (NYSE:UPS) or Expeditors (Nasdaq:EXPD) can open new offices and facilities around the world, Arkansas Best or other truckers like Swift (Nasdaq:SWFT) can't just decide to expand in Germany or China if they want to do so.

What Arkansas Best is doing, though, is trying to embed itself deeper into its customers' shipping process and needs. Although the company has a long way to go to prove that this can be a long-term boon to profits, it at least makes sense that it could make Arkansas Best "stickier" in its accounts.

Structural Issues
Arkansas Best has some very definite challenges when it comes to competing in the trucking market. Rival less-than-truckload carrier Old Dominion (Nasdaq:ODFL) still has an organic growth kicker that comes from adding new service centers around the country and expanding its fleet. That's not really in play for Arkansas Best.

Costs are also an issue. Arkansas Best has a union workforce and that costs the company - not only in higher wages but in less flexibility to reduce costs in response to market conditions. Worse still, it's hard to show how the company gets what it pays for - while turnover at Arkansas Best is low by industry standards, none of the metrics of long-term company performance show any edge to having a more stable and arguably better-trained roster of truckers.

The Bottom Line
That union workforce issue may make it harder for Arkansas Best to cut costs, but the good news is that there's plenty left to cut. Assuming that higher prices don't completely melt away the volume and the company can improve that operating ratio, there's still plenty of potential operating leverage.

So what's a fair price for Arkansas Best? Grant the company it's long-term forward EV/EBITDA multiple and it looks as though the stock could rise 50%. Chop 20% of that historical multiple, and fair value on the stock is still 25% above today's price. Maybe Arkansas Best doesn't deserve the multiple of the past (since growth is getting more challenging), but this could be an interesting turnaround if management can somehow deliver better operating performance. (For related reading on how to value Arkansas Best, see 4 Steps To Picking A Stock.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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