February 9, 2005
Luc Mageau Bcomm (780) 473-1618
Editor: Ian Madsen, MBA, CFA; Tel: 1-800-767-3771;x.417
www.zackspro.com 155 North Wacker Drive l Chicago, IL 60606
CNF Inc. (CNF – NYSE) $45.20
This is a new, original, initial report. Subsequent updates will have new or revised material highlighted.
Overview
Headquartered in Palo Alto, California, CNF is the holding company for the third-largest less-than-truckload (LTL) company in the U.S. (Con-Way Transportation), as well as a $1.1 billion global logistics operation (Menlo Logistics), which specializes in reducing supply chain and inventory costs primarily for large companies with complex distribution networks. CNF has a separately reported joint venture (Vector SCM) with General Motors.
Vector SCM is a large-scale partnership with General Motors to serve as the lead logistics manager for the vehicle manufacturer and involves all aspects of General Motors’ supply chain, from shipping parts to manufacturers to the delivery of vehicles to dealers. Con-Way operates as a nationwide non-union LTL carrier traditionally focused on fast-cycle regional freight (typically overnight or two-day shipments), but capable of handling all types of shipments (with a network of over 450 service centers). Also, in 2005, Con-Way has started up its own internal Truckload unit with the aim of internalizing some of its third-party transportation costs for line-haul moves between regions. The company recently announced it has approved a share repurchase program estimated at $300 million.
More information on CNF can be found at their website at www.cnf.com.
NOTE: CNF’s fiscal year ends on December 31; all calendar references are to the fiscal year.
Positive Arguments / Strengths / Negative Arguments / Threats· Non-Union worker flexibility
· 2004 saw a sharp increase in productivity
· Forwarding division was sold in December.
· New $300 million (10% of outstanding shares) share repurchase.
· Company continues to improve operating margins, and is mostly due to cost cutting
· Multiyear improvement in network capacity expected.
· Primary operations division (Con-Way) is strong, and also has strong margins. / · Increased demand in 2004 led to much higher overtime wages, and bonus levels (expected to decrease going forward).
· Multiple restructuring charges and write-offs, and money-losing freight forwarding segment.
· Con-Way operating margins deteriorated yoy in a very strong LTL environment, indicating weak pricing.
· Analysts expect stronger performance from rail transport (as opposed to surface and Air transport) in near future.
· Maintained strong fuel pricing.
Analysts agree that the company has experienced strong growth and results thus far. In addition to this the $300 million share repurchase is expected to be a large factor for earnings in the next couple of years. Analysts do mention however, that the company has recently experienced flat margins (minimal growth), and with a stronger rail transport industry, the company may experience higher competition in the near term.
Sales
[2003]A / [2004]E / [2005]E / [2006]E / 03 - 06 Growth / 04-05 Growth / % of 04A total RevCon-Way / $2,186 / $2,565 / $2,796 / $3,006 / 37.51% / 9.01% / 69.10%
Menlo / $1,012 / $1,103 / $1,233 / $1,354 / 33.79% / 11.79% / 29.71%
Other / $0 / $5 / $7 / $5 / - / 40.00% / 0.13%
Total Revenue / $3,611 / $3,712 / $4,086 / $4,466 / 23.68% / 10.08%
The company is expected to have strong revenue gains going forward, both in a long term perspective, and short-term. The majority of the revenues however, are expected to come from Con-Way. The growth in revenues is due to strong industry pricing going forward, and a strong transport industry in total.
Compared to peers, we can compare CNF from the following table, which was extrapolated out of one analyst’s (Raymond James) report:
Worker Productivity Analysis: Average Revenue per Employee
Figures Based on 2003 Data
Con-Way / $132,300Yellow / $128,500
Arkansas Best / $123,200
Roadway / $119,500
FedEx Freight / $117,400
Overnight / $103,800
Saia Motor / $101,100
Old Dominion / $92,400
USF Corp. / $89,100
Source: Company Filings, U.S. Dept. of Transportation, RJ Research
Geographic Sales Breakdown:
No breakdown of geographic sales was available either from analyst reports or the company’s 2003 annual report (2004 not yet available).
Please see the separately saved spreadsheet for more details.
Margins
Company Wide Margins
[2002]A / [2003]A / [2004]A / [2005]E / [2006]E / Trend (up/down)Operating Margin / 3.30% / 6.10% / 7.60% / 8.10% / 8.30% / Up
Pre-Tax Margin / 2.80% / 5.30% / 6.60% / 7.40% / 7.60% / Up
Net margin / 2.00% / 3.20% / 4.00% / 4.50% / 4.60% / Up
The company is expected to maintain margins through 2005 and 2006, however is not expected to experience much growth. As previous, increasing competitiveness of the market combined with tighter pricing may be a contributing factor to this.
Sector Operating Margin / [2002]A / [2003]A / [2004]A / [2005]E / [2006]E / Trend (up/down)Con-Way / 6.90% / 8.80% / 9.90% / 10.40% / 10.70% / Up
Menlo / 5.40% / 4.10% / 3.80% / 3.60% / 3.10% / Down
From here it is plain to see that Con-way is expected to, and has dominated the company’s margins. Menlo has suffered from continuously declining operating margins (nearly to half of 2002 levels) where Con-Way has nearly doubled. This is because the market for Menlo products (specialized services for reducing costs of supply chain management) has become very competitive, and pricing very compressed.
Please see the separately saved spreadsheet for more details.
Earnings per Share
Fiscal Year Ended Dec 31 / [Q4 04]A / [Q1 05]E / Qtr Growth / [Q2 05]E / [Q3 05]E / [Q4 05]E / YOY Growth / FY 05E / FY 06E / YOY GrowthManagement Guidance / $0.57 - $0.65
Zacks Consensus EPS / $0.61 / $0.82 / $3.23 / $3.78 / 17.03%
Digest Average EPS / $0.74 / $0.61 / -17.57% / $0.80 / $0.93 / $0.88 / 18.92% / $3.26 / $3.84 / 17.79%
Digest High EPS / $0.74 / $0.65 / -12.16% / $0.86 / $1.02 / $0.93 / 25.68% / $3.40 / $4.25 / 25.00%
Digest Low EPS / $0.74 / $0.59 / -20.27% / $0.63 / $0.84 / $0.80 / 8.11% / $3.02 / $3.40 / 12.58%
Please see the separately saved spreadsheet for more details.
Target Price/Valuation
We had eight target prices available to us. All firms used a multiple to EPS and ranged from a multiple of 12X to 16X. Most firms applied this multiple to 2005E EPS, but some used it on 2006E EPS. Two firms used an EBITDA multiple in addition to the EPS multiple method. The highest target price was given by (Thomson, Davis.) which used a target price of $63.00, and the lowest estimate, given by (CSFB) used $45.00.
Our average price target was $54.75, compared to Zacks consensus of $52.50.
Please see the separately saved spreadsheet for more details.
Upcoming Events
EVENT
/DATE
CNF Inc. at Deutsche Bank Conference / February 16, 2005Q1 2005 Earnings Results / April 25, 2005
Other Discussion/Capital Structure/Cash Flow/Solvency/Governance
None warranted at this time.
Long-Term Growth
The main factor that will affect long term growth for CNF will be their labor force advantage. Analysts state that the company’s incentive-based culture has driven improvements in customer service and developed industry leading worker productivity. In turn, Con-Way accordingly charges premium rates for its higher service levels relative to its competition. This pricing structure, coupled with its productivity, thereby allows Con-Way to pay wages and benefit packages often commiserate with unionized operations while generating margins usually twice that of some peers. Also the flexibility of the labor the company employs allows for higher flexibility, and employees usually perform the duties of two workers (dockworker, and driver). This advantage will prove useful in the long term, as they are allowed to benefit from increased margins, and a lower pay structure.
Analysts also note that transit time is a large player in CNF’s long-term growth. The company currently has shorter time than its competitors, which allows for more profitable service. Due to the company’s structure, analysts expect this advantage will endure into the long term.
Individual Analyst Opinions
POSITIVE RATINGS
Raymond James – Stock is rated Strong Buy (Last updated Jan. 1-2005). The company’s visible growth prospects, industry-leading margins, much-improved balance sheet, and accretive repurchase program should all help sustain a premium valuation relative to its regional LTL peer group. The analyst expects the company to maintain lowered corporate overhead expenses, improve network density (with “bricks and mortar” capacity), and benefit from the stock repurchase program.
R.W. Baird– The stock is rated Outperform (Last updated Jan. 25-2005). Rating is based on the completion of the divestiture of the forwarding division clearing the way for investors invest in this regional LTL, Con-Way, which now generates nearly 90% of CNF profit. They also note that overall capital returns in excess of 15%, puts CNF in the best-in-class range for asset-based transports. This being said, the remaining Logistics division is at competitive disadvantage without the forwarding capabilities, but provides a positive cash flow stream. Tight domestic freight capacity, internal leverage, and accretive share repurchase, and the analyst expect CNF to sustain 20%+ EPS growth into 2006.
Bear Stearns – The stock is rated Outperform (Last updated Jan. 25-2005). The analyst expects CNF to continue taking appropriate measures to reduce cost, shrink the holding company and to unlock shareholder value through share repurchase asset sales and potentially the strategic sale of the company to the right strategic purchaser. The current $300M share repurchase is another example (after the sale of Menlo Forwarding) the analyst believes of management creating value for shareholders. The opportunity for additional share repurchases or an asset spin-off remains strong, and may improve value further in the future.
Merrill Lynch – The stock is rated Buy (Last updated Jan. 25-2005). The share repurchase program is almost double the buyback that the analyst anticipated from the proceeds of the Emery sale to UPS in the quarter. They also expect pricing in the industry to remain strong, benefiting all companies. Further to this, added confidence in the new CEO is believed to add value.
Smith Barney – The stock is rated Buy (1) (Last updated Jan. 31-2005). The analyst feels the fundamentals of the LTL industry remain favorable with solid pricing and continued improvement in tonnage; this bodes well for the contribution of Con-Way to results in 2005. As well, the sale of the underperforming Menlo Forwarding unit at the end of the year should enable management to focus more intently on operating the remaining profitable businesses while improving shareholder value. This coupled with intended debt reduction should translate into improved earnings in the coming years.
Thomson, Davis – The stock is rated Buy (Last updated Jan. 31-2005). The logistics division of the asset light group may benefit from cost and revenue efficiencies. This combined with added benefits of the $300 million share repurchase was the main reason for the rating.
NEUTRAL RATINGS
CSFB – Stock is rated Neutral (Last updated Jan. 25-2005). The analyst believes the market is appropriately discounting potential profit growth. The analyst incorporated the effects of the $300 million in share repurchases. The analyst was also discouraged that management guidance implied a top-line growth as opposed to margin improvements.
Deutsche Bank – Stock is rated Neutral (Last updated Jan. 25-2004). The analyst thinks more upside is needed to mitigate concerns about tougher comparisons and the potential for a multiple compression in the industry. They do note that long term growth looks favorable now that they have sold the Menlo Forwarding sector. Benefits from the $300 million share repurchase were incorporated into their model.
J. P. Morgan – Stock is rated Neutral (Last updated Jan. 24-2005). The analyst notes that valuation is fair given the prospects of a continued strong trucking environment in 2005 offset by some management uncertainty and execution risk. The analyst does expect the industry to remain strong, however, notes that CNF is not at a significantly better competitive advantage going forward.
NEGATIVE RATINGS
MSDW – Stock is rated Underweight (Last updated Jan. 26-2005). Although they expect the industry to perform in-line with the broader-based market over the next 6 to 12 months, they see the best prospects for parcel carriers followed by select railroads, and are cautious about the trucking industry. They also note that CNF’s premium P/E multiple of 15.7x (based on their earnings model) combined with concerns that LTL fundamentals are unlikely to improve from here they maintained an Underweight rating. Further, CNF operating margins deteriorated yoy in arguably the strongest LTL environment in well over a decade. The analyst interpreted this as LTL pricing, while firm, is not improving as many on the Street expect.
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