As the name implies, publisher Wyatt Investment Research takes a research-heavy approach to much of their stock selection. Today’s Daily Alert features (part of) a typical new recommendation from Wyatt’s Top Stock Insights, edited by Ian Wyatt and Jason Cimpl. It’s longer than our usual Daily Alert fare, but it’s a good, detailed turnaround story — and as you may recall from our latest issue, turnarounds are having quite the banner year thus far.
“Quality Distribution, Inc. (QLTY) is a great trucking company whose shares have taken a beating. However, investors shouldn’t let that decline sway them from owning the stock. This is a great stock to own near $9.75 because Quality Distribution has two advantages over the competition.
Advantage 1: They don’t own trucks
“Unlike most truckers, Quality Distribution doesn’t own trucks. The approach helps keep debt levels and operating costs low. ... By managing through an affiliate network, Quality Distribution avoids high costs such as tractor purchases, maintenance, terminals and fuel. It’s able to focus more resources on driving new sales and lowering back-office costs. Though the strategy sounds great, management was unable to implement it correctly — initially.
“They wanted to manage a network and operate their own fleet of trucks. Management also took a ‘quantity was greater than quality’ approach to finding affiliates, which ballooned out of control. The revenues continuously grew, but Quality Distribution remained unprofitable until 2005. After two more bumpy years, trucking industry veteran Gary Enzor took the helm as CEO in 2007. ... Enzor quickly divested Quality Distribution of non-core operations. He also cut down the affiliate network. By decreasing the number of affiliates, Quality Distribution was living up to its namesake —favoring quality over quantity. This adjustment allowed the company to focus on high-growth business segments and working only with the strongest partners. The result was higher margins and more favorable contract terms.
“The company quickly profited from the appointment of Enzor as CEO and commitment to an asset-light strategy. Enzor’s solid management skills and revamped affiliates should help drive record business growth at the company. By operating through an affiliate network, Quality Distribution is able to diversify its customer base, geography and end market. This scale allows Quality Distribution to provide safer and more reliable service to its customers. In turn, it’s easier to earn long-term contracts with those businesses. Long-term customers are important in the trucking industry. An established long-term client base acts both as a barrier to entry and growth driver. ...
Advantage 2: Huge growth in the United States
“The newly found focus resulted in the acquisition of Boasso, which proved to be exceptionally prescient. Through the acquisition, Quality Distribution quickly became the largest provider of chemical intermodal and ISO container services in North America. ... Because natural gas is a major input for chemical production, years of low gas prices resulted in massive growth from North American chemical manufacturers. As U.S. chemical makers ramped up production, more shippers were needed to transport those goods.
“Due to savvy decisions from the past, Quality Distribution quickly found itself operating at the forefront of America’s fastest growing industrial segments. Between the affiliate network and trucks at Boasso, Quality Distribution controls 15% of this market. Moreover, Quality Distribution is unlikely to lose ground in this segment. The chemical bulk tank industry requires specialized trucks, equipment and drivers. The specialized nature and high safety requirements create natural barriers to entry that will protect its perch as a market share leader. ...
“In addition to the low-cost business model and chemical distribution, Quality Distribution is moving into the lucrative oil and frac-shale energy industry. Late last year, QLTY won a multi-year contract to provide fresh and disposal water hauling services in the Marcellus shale. The company also began hauling oil in the Eagle Ford shale region of Texas. The fracking process involves pumping fluids into the ground, forcing cracks in rock. This allows oil to flow through the cracks. While the process is basic, it uses a lot of fluid. Additionally, the fracking process quickly pollutes the fluid. Drillers need trucks to carry it for cleaning off-site. The amount of drilling done with fracking increased dramatically over the past few years, which has created a huge market opportunity for transporters. Also, the experts don’t expect this production to slow down any time soon. ...
Despite its advantages, QLTY is cheaper than its competition
“Quality Distribution successfully utilizes a low-cost, high-growth strategy. However, its stock lost a third of its value from a $14.61 high this year. Why? The fall in oil may have spooked investors. Many feared the softness in oil was a result of fundamental weakness in the economy. Such a slowdown would have a negative impact on transportation stocks.
“But we don’t believe the U.S. economy is heading into recession. Furthermore, Quality Distribution’s business remains strong. In fact, analysts have actually raised estimates. Twelve analysts follow their stock. This year, analysts expect $0.99 EPS, up from a $0.90 estimate three months ago. Next year, they project earnings of $1.30 per share, up from a $1.12 estimate in April.
“At $9.75, the stock trades with a P/E around 10. Quality Distribution usually commands a 12.5 P/E multiple, making the shares roughly 20% undervalued. However, the industry average P/E is 17.5, or over 75% higher from where the shares now trade. Our 12-month price target of $14 is a happy middle ground between the two historic multiples.”
- Ian Wyatt and Jason Cimpl, Top Stock Insights, July 17, 2012