A major issue facing publicly traded carriers is the potential for a further decline in the stock market. Trucking is an industry with lower P/E multiples and only marginal opportunities to improve earnings per share. That combination could cause further trouble in the market valuation of trucking companies.
To establish a fair market price, stock evaluators look at a carrier's discounted stream of earnings. This simply means they determine the likely stream of earnings per share, or EPS, for a period of time, usually at least 10 years. Next they determine a fair market discount rate to establish the current value of these future earnings. The sum of each period's discounted EPS yields the fair market value for the stock.
It's obviously important to get the two valuations right.
For the EPS valuation, analysts, myself included, are well versed in looking at a carrier's history. Sometimes, hindsight is better than no sight at all. Analysts will look at recent earnings per share for the trucking industry as a whole, and then for individual carriers They then determine whether the pattern is likely to continue over the valuation period or whether some change — positive or negative — is in store.
Analysts also look at individual trucking firms to see whether their performance relative to their counterparts can be sustained or changed over time. That requires careful analysis of each carrier's market and operating strategy. Since very few analysts are able to determine that accurately, they tend to stick to the trend values.
Consequently, trucking companies will go along with the herd to get short-term valuations in line. However, that approach may not lead to long-term comparative strength. Meeting an analyst's quarterly earnings estimates has been a crippling factor for companies of all types, and it's not likely to change any time soon.
Basic finance courses teach that a company's discount rate is based on three elements: the expected rate of inflation, a measure of the ongoing strength of the overall economy, and a combined measure of the performance of trucking as a whole and the relative position of the particular carrier being evaluated.
Evaluations of performance are based on the short-term impacts on EPS. Consequently, financial analysts believe that to maximize shareholder wealth, carriers must adhere to the strategy of maintaining a steady profit stream. That stream is currently at risk, and will be for at least a year.
When the economy softens, trucking gets hit with a double whammy. First, traffic levels slow down and revenues decline. Second, fleets have to reduce rates so they can utilize their equipment. Both factors will likely result in lower profit margins (EPS).
Downsizing in times of economic decline is not always an option. In fact, it may be in the best interest of a carrier to keep its trucks moving in order to retain drivers, even though the freight being hauled is much less profitable, if at all. In addition, since there is excess capacity in slower times, equipment values fall, which makes selling assets less appealing.
In addition to overall freight rates, charges for special services also decline. As a result, fuel surcharges will be renegotiated and fees for special handling will be as well. The result is lower EPS
This scenario is not new to trucking, and carriers have been able to manage through it before. They'll be able to do so again, but one consequence is that we might see more publicly traded trucking companies going private. That's an option that could provide more flexibility in developing a long-term strategic position than by jumping through hoops every quarter to impress the analysts.
