Betting on another Distressed LTL Carrier: Vitran

A lot of my ideas are built upon the work of other people. I spend a great deal of time scouring blogs, watchlists, tweets, message boards and the like, looking for an opportunity that someone else has discovered and that I think deserves a closer look.

Every once in a while I am lucky enough to come across an excellent write-up that encompasses the idea so clearly that I do not have to do all the work myself.  I found this sort of  write-up with Alliance Healthcare a few months ago, though unfortunately since it was published on SeekingAlphaPro it is only available to premium subscribers now (of whom I am not one).

I found an equally good write-up on my latest company of interest, Vitran Corp. The write-up (accessible here), was written by someone who goes by the pseudonym AIGSwap, and does an excellent job of encapsulating the essence of the idea. I recommend reading it before proceeding. All that I plan to do here is provide my own color and update a few important operational changes that have occurred since its writing.

Vitran Corp (VTNC) is a less-than-load trucker (LTL). This is the same business as YRC Worldwide and Arkansas Best. While Vitran does not struggle with unionized labor costs like YRC Worldwide and Arkansas Best do, they certainly have struggles of their own. In the first quarter, the company posted an operating ratio of 109. Operating ratio is a commonly used industry metric of operating profitability, and is simply the total operating expenses divided by revenues. The best LTL carriers will have operating ratios in the low 90s, the achievement of YRC Worldwide in the first quarter was to break 100 on their Freight business, and if you have an operating ratio of 109 like Vitran does you are losing a significant amount of money.

What makes Vitran interesting is that not all of their operations that are so unprofitable. The company operates LTL in both Canada and the US, and while they do not break-out the Canadian operations from the US operations, they have provided enough color on past conference calls to make it clear that the Canadian operations are consistently showing mid-90s operating ratios.

The Sale of SCO

In addition to the two LTL businesses, up until the first quarter of this year Vitran operated an asset-light trucking logistics business called SCO. In March they sold SCO for $97mm in cash. Part of the cash was used to reduce their existing revolving loan facility, and the rest was put on the balance sheet for future use.

Prior to the sale the enterprise value of the company was about $200 million. The sale of SCO monetized nearly 50% of enterprise value. With respect to the two remaining businesses, the obvious question is whether the Canadian and US operations are worth more or less than the remaining value of the enterprise, which at $5 per share is $113 million. Given the circumstances I will outline below, I think there is a reasonable case that they are.

The Canadian Operations

Based on the analysis presented by AIGSwap the Canadian operations can generate $16mm of EBITDA.  I am going to suggest, based on my own, perhaps more conservative calculations, that the number is closer to $14 million.  Here is my estimate of EBITDA for the Canadian business over the last 3 years using an assumption of a 95 operating ratio.  Note that I eliminated D&A as a proportion of revenue.

Canadian competitors Transforce, Contrans and Mullen Group trade in the range of 7-7.5x EBITDA (albeit none of these companies are perfect comparisons because they all operate a more diversified Canadian trucking platform than Vitran). At 7x EBITDA the Canadian operations would be valued at about $98mm or about 86% of the current enterprise value.

As an aside, while the company doesn’t report quarterly revenue for its Canadian operations, they did make the following comment in the 10-Q, which suggests that there hasn’t been any deterioration in the Canadian business.

The Canadian LTL business unit posted a solid 2013 first quarter benefiting from a renewed commercial effort in the Canadian market place.

Are the US operations worth anything?

Here is a brief history of the Vitran US LTL business over the last year.

Last January Vitran hired a former Fedex executive Chris Keylon to head up their US LTL division. By all the accounts I have read, Keylon shook up the division, replacing management and introducing a tremendous amount of new technology.

The transition hasn’t gone well.  Growing pains associated with the changes and, based on anecdotes I read, less than full acceptance of those changes from the employee base has led to poor service and the subsequent loss of customers. This culminated at the beginning of April when the CEO, Rick Goetz, left the company. Much of the scuttlebutt around his departure suggests that the decision was not his alone, and that the subsequently announced first quarter results (in which the terrible 109 operating ratio was reported) was the last straw.

A perusal of the trucking message boards provides a decent snapshot of just how tough things are at Vitran right now. While I’ve read enough of the trucking message boards through my interactions with YRC Worldwide and Arkansas Best to realize that they are skewed towards negativity (an investor relying entirely on message boards would never have invested in the YRC Worldwide turnaround) the level of vitriol for Vitran is at a higher level.

Given that things are bad at the US operations, why would I want to invest in this stock on a premise that depends on the value embedded in the US operations? I have three responses to this:

1. On the first quarter conference call the interim CEO, Bill Deluce, said that “the board was very determined to maximize shareholder value… has mandated us to review the operation and come back with a revised plan…The board is not satisfied to sit and wait. The board expects shareholder value enhancement to take place in a very short period of time, they have us very focused on that mandate.”
2. According to the trucking boards, as of Tuesday Vitran announced that they would be shutting down much of their West Coast operations including Reno, Las Vegas, Phoenix, Denver, Portland and Seattle
3. Things are getting better in the LTL world.  There has been an across the board increase in rates of 5.9% announced by the carriers and there are plenty of anecdotes about companies hiring workers.  I have found that troubled companies at industry turns often see good things happen to them.

On one of the conference calls before he left Goetz pointed out that the Western Operations were somewhat removed and isolated from the consolidated operations they had in the mid-east. The north-eastern operations are also a fit with the Canadian business, as they facilitate highly profitable trans-border business.  From what I have read on the trucking boards, the Western operations have been losing a significant amount of money and have been perhaps the primary source of the overall losses on the US LTL business.

I can’t give you a road map of what is going to happen next, but the motivated board, the moves that have occurred already, and the positive industry dynamic suggest to me that more may happen shortly.  My suspicion is on one of two end-games.  The US operations are either going to be shrunk down to a much smaller size, to act as a profitable complement to the Canadian business, or they are going to be downsized with the intention that the attractive parts will be sold off, and the Canadian business will go it alone.

And my opinion is that with either of these options the ultimate enterprise value of the resulting business is going to be worth somewhat more than the existing enterprise value.  This maybe isn’t a three or four-bagger type of story, but I could see the US operations being worth $30-$40 million (which would be an incremental $2-$2.50 per share).  Given the expedited time frame I am expecting, its a decent bet to take.  And there is always the chance that we are surprised.

I took a 3% position in the stock. Its not a huge position and I don’t expect it to become excessively large.  As usual I will watch the news (and in this case the boards) closely to see how it unfolds.