Knight-Swift Transportation – Potential upside from attractive valuations and merger synergies

Summary

  • The merger of two US trucking companies Knight Transportation and Swift Transportation results in the creation of the largest truckload fleet operator in North America.
  • The company is on track to reaping the synergistic benefits from the merger.
  • The combination of synergistic benefits and attractive valuations give this stock good upside potential.

 

The creation of a trucking giant

In April 2017, Knight Transportation and Swift Transportation announced that they will merge to create a giant trucking company with $5 billion in revenues and which will operate 23,000 tractors, 77,000 trailers, and will have 28,000 employees.

With benefits of economies of scale, the two companies are expected to enjoy lower operating costs and higher profitability. Net Profit Margin is estimated by analysts to go up from 7.62% in FY2018 to 8.53% in FY2019 and 9.24% in FY2020.

CEO David Johnson said, “We look forward to learning from each other’s best practices as we seek to be the most efficient company in the industry.” Swift Transportation’s Chairman Richard Dozer said, “By coming together under common ownership, the companies will be able to capitalize on economies of scale to achieve substantial synergies.”

 

Stock Valuation

Despite the favourable prospects, valuations are still attractive. We first look at valuation from the standpoint of popular indicators – Price to Earnings, Price to Sales, Price to Cash Flow, Price to Book and Dividend Yield.

At the price of USD39.81 as at 30 May 2018, Knight-Swift Transportation Holdings Inc is trading at a PE Ratio of 11.4 times last 12 months earnings.  This is a 46.0% discount to its historical average Price to Earnings Ratio of 21.2 times. (Price based on the historical average PE of the company is indicated by the red line.)

Note: The aberration in FY2017 earnings is due to tax credit.

At the price of USD39.81 as at 30 May 2018, Knight-Swift Transportation Holdings Inc is trading at a Price to Sales Ratio of 1.9 times last 12 months sales.  This is a 5.0% discount to its historical average Price to Sales Ratio of 2.0 times.                                                                                                       

At the price of USD39.81 as at 30 May 2018, Knight-Swift Transportation Holdings Inc is trading at a Price to Cash Flow Ratio of 14.1 times last 12 months cash flow.  This is a 22% premium to its historical average Price to Cash Flow Ratio of 11.6 times.                                                                                                       

While the above three indicators value a company based on what it is generating (i.e. profits, sales or cash flow), Price to Book ratio values a company based on what it owns (i.e. its net tangible assets).                                                                       

At the price of USD39.81 as at 30 May 2018, Knight-Swift Transportation Holdings Inc is trading at a Price to Book Ratio of 1.3 times current book value.  This is a 54% discount to its historical average Price to Book Ratio of 2.8 times.

At the price of USD39.81 as at 30 May 2018, Knight-Swift Transportation Holdings Inc is trading at a Dividend Yield of 0.6%. This is a 34.9% premium to its historical average Dividend Yield of 1.0%.  (Note: The lower/higher the dividend yield, the more expensive/cheaper the stock is.)                                                                                                     

Everybody has his favourite valuation indicator. Although most people would use Price to Earnings Ratio to value stocks, others believe that profits are open to manipulation and Price to Cash Flow is a better measure. Yet others rely on Price to Sales Ratio to value companies as this measure can be used even at times when the company is not profitable. Another way to value companies would be to value its assets and typically the Price to Book Ratio is used for that. Income investors who invest mainly for dividend income like to use the Dividend Yield to find companies that are undervalued.

We believe that each of these methods has its pros and cons. Furthermore, different types of stocks suit different valuation methods. Therefore, we reckon that the best way is to use all five indicators and let empirical data find us the best possible combination of these five indicators that explains the stock’s price. You can read more about our methodology here.

In addition, different indicators will give you different signals. Some may tell you it is overvalued while some tell you it is undervalued. This is no help to an investor who must make a definite decision whether to buy, hold or sell the stock.

Using a combination approach, we found a Composite Valuation Indicator that explains the stock price better than any of the standalone indicators above. And it gives you one signal to decide whether to buy, hold or sell the stock.

Based on the Composite Valuation Indicator, the stock has a Target Price of USD55.63 over the next 12 months. Our Target Price represents upside of 39.7% based on stock price of USD39.81 as at 30 May 2018. Since this is an ambitious target, investors may do well to take profit when stock price is up 25% from current values.                                                                                          

Other Considerations

Of course, in deciding whether or not a stock is attractive, it is more than determining its valuation. We need to consider other aspects of the stock such as growth, earnings quality, financial condition, operational excellence, cash flow, technicals, etc.

It is difficult to find a stock that is attractive valued and still pass every single criterion of the investor with flying colors. At times, we need to make certain trade-offs.

For a full quantitative analysis, you could refer to this report.

Conclusion

We believe that Knight-Swift Transportation is a good stock with profit potential over the next 12 months. Our recommendation is based on the fact that earnings prospects look good with synergistic benefits of the merger. The stock also looks attractive on a valuation basis and we use a thorough valuation methodology that combines five valuation indicators in an optimal way to best explain the stock price.

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