Keep on Trucking

Patriot Transportation Holding (PATI) is a tank truck company operating in the southeast United States and, based on 2017 revenues, the 10th largest bulk carrier in North America.  Perhaps unsurprisingly, among publicly traded competitors in the trucking industry, you will find the widest array of market valuations.  You will find companies trading near all-time highs (ODFL, JBHT), as well as a recent large bankruptcy (CGIP).

Generalizing across all companies in this industry space is likely akin to making a Procrustean bed, but there are some difficult challenges that seem to be facing a number of competitors–namely, driver shortages, driver turnover, and rising insurance costs.

Patriot addresses some of these concerns directly in their recent shareholder letter from the CEO and President Robert Sandlin.  In appreciation for his candor and willingness to say the hard things, I quote the letter in its entirety:

“Fiscal year 2019 proved to be very challenging as the driver market continued to tighten. Revenue came in at $109 million, well below the $114 million we generated in fiscal 2018. The lower revenue was mainly driven by a decreasing driver count and the closure of our Charlotte terminal in May of 2019. We ended the year with an average count of 538 drivers versus 580 in fiscal year 2018. Just prior to the beginning of fiscal 2019, in an effort to reverse the trend of a declining driver force, we implemented a new productivity/minimum guarantee pay program. While the program provided a significant boost to driver hiring, it did nothing to reduce turnover and ultimately resulted in us spending significantly more on training and driver pay in fiscal 2019. In early October 2019, after gaining input from our drivers, we announced an overhaul to the driver pay program that eliminated the weekly productivity/minimum guarantee pay program and added seniority pay raises, weekly productivity bonuses, and a Paid Time Off Buyback Program, among other enhancements. We are hopeful these enhancements will continue to attract new drivers but, more importantly, will incentivize all our drivers to remain employed with the Company for years to come.

A great deal of our success is dependent upon our ability to increase revenue at good freight rates. Our strategy is to concentrate revenue growth efforts in the markets where we have been successful with driver retention and to diversify our product mix where we can achieve revenue growth and improve profit margin. Recently, we closed on the acquisition of the assets of Danfair Transport out of Americus, GA which had total revenues of approximately $2.3 million in 2018. We are excited about this acquisition as it fits nicely into one of the most stable market areas in our network and provides an opportunity to grow with some new customers in other markets we serve.

Controlling our fixed expense is critical in a declining revenue environment. During fiscal 2019, we reduced our average tractor fleet from 383 to 330 to remain aligned with our target of at least 1.5 drivers per tractor. On an annualized basis, this reduction will save the Company approximately $750,000 in depreciation expense alone.

Unfortunately, we were also forced to make headcount reductions during 2019 as we focused on keeping our support wages and SG&A expense at or below our targeted percentage of revenue. The reductions are projected to save the Company in excess of $750,000 in fiscal 2020.

We continued to search for ways to reduce costs associated with our employee benefit plans. During fiscal 2019, we implemented changes to our health, wellness and pharmacy plans that project to provide an annualized savings in excess of $1 million in fiscal 2020. These savings allowed us to keep our employee premium costs flat for the second year in a row while adding better benefits to the plans. We are hopeful that achievements like these will continue to set us apart from our competition and build a stronger workforce for our Company.

The auto liability insurance market continued to tighten in 2019 and resulted in a meaningful increase in our annual premium cost for fiscal 2020. While we were fully able to absorb the cost increase and maintain liability insurance well in excess of our customers’ minimum requirements, some of our competitors may struggle to do the same. Whether this leads to less competition, higher freight rates, consolidation or all of the above is yet to be seen, but it stands to be a big part of the industry story for the remainder of 2019 and into the future.

Finally, technology investments have played a large part in the past couple of years. During 2019, we completed several technology projects that included a new billing automation platform and a complete migration of our critical operating systems to a 3rd party cloud service provider. These implementations have helped us reduce costs and improve efficiencies across our network. Looking into 2020, we plan to begin piloting an on-board tractor camera system to assist us in managing our auto insurance claims and to improve driving behavior. Furthermore, we plan to implement a new automated dispatch module that should bring significant efficiencies to our operations and customers. We believe these projects are critical to our future success as they provide significant benefits to our drivers, employees and customers.

We want to thank our employees for their dedication to our Company and to providing the highest level of safety, professionalism and customer service. Our non-driver employee workforce consists of some of the finest people in the industry and we are consistently recognizing employees for 10, 20 and even 30 years of dedicated service each year at our annual meeting. We truly value their loyalty and leadership within our organization.

We are very proud to say that in fiscal 2019 the company beat our preventable accident frequency target. We set a very high standard for ourselves each year and achieving this goal speaks volumes about our drivers as well as our dedicated managers. Achieving this target allowed us to give away a brand-new Chevy Silverado to one of the Company’s many eligible, accident free drivers in 2019. Congratulations to Marco Rollins on winning this year’s award. The joy in Marco’s voice when he answered the phone call during our annual awards dinner was priceless and makes what we do every day well worth the effort. I also want to recognize Ron Stanley as the recipient of the Company’s John R. Mabbett Award for 2019 Driver of the Year. Ron is a veteran who served in the United States Army and we’ve been fortunate to have him on our team for the past six years. He has been a strong and consistent leader and exemplifies our determination to exceed customer expectations in safety, quality and service. Ron, we thank you for dedication and commitment to our Company.

While fiscal 2019 fell well below our expectations on profitability, our balance sheet remained strong, we continued to replace older tractors with new equipment using cash from operations and grew our shareholder equity by $2.4 million. We currently hold $21 million in cash and investments and have no outstanding debt.  The Company is poised to invest in business opportunities like the Danfair acquisition should those opportunities continue to arise. During fiscal 2020, we will be exploring opportunities to expand our chemical business and are currently consulting with a chemical industry veteran to gain a better perspective on opportunities to grow chemical revenues in several new lanes. We believe we are taking the necessary steps to be successful in the future. Our management team is committed to satisfying our customers’ needs and achieving a solid return on investment for our shareholders. As always, we do not take your continuing investment in our Company lightly and we want to thank you for your continued interest and support.

Respectfully,

Robert E. Sandlin, President & Chief Executive Officer

Thompson S. Baker II, Chairman”  [10-k]

From my armchair, it looks like Patriot is playing a difficult hand as well as one can.  With 3.35 million shares out and a share price of $17.30, you have a market cap of $58 million.  Their book value of $54.8 million at 9/30/19 includes more than $21 million of cash and investments that exceed the liquidity requirements for this type of business.  With the reduction in fleet size and sale of excess equipment in 2019, free cash flow was in excess of $4 million for the last fiscal year.

Disclosure: No position

How Google Kills the NY Times

On the Trade Desk (TTD) conference call earlier this month, the first analyst question highlighted the upcoming changes to Google Chrome and asked about the effects they may have on the ability of advertisers who use cookies to track and target visitors.

Apple has already made similar changes, as CEO Jeffrey Green explains:

“Apple made some changes called ITP to their browser where they decided to just block [off] the use of all third-party cookies about a year ago and replace it with what they call ITP, which was essentially an algorithm that would decide what third-party cookies would be allowed to persist instead of both first and third parties doing well no matter what or existing on the browser no matter what.”

However, this change does not significantly affect Apple’s revenue to the same degree as it may for Google, since Google makes “95% of its money through advertising,” and Chrome has a much larger market share.

Going forward, Chrome users will be able to turn-off third party cookies.  And though Green does not expect many users to take advantage of this new feature, it does expose a potential vulnerability to their main revenue source.

As Green concludes:

“I think if there’s any meaningful adoption of consumers opting out, it will then beg the question or force the discussion with companies like The New York Times between them and their users to say if you get rid of targeted advertising, you turn $8 CPMs into $4 CPMs and I can’t run my business anymore…

If they were to take away targeted advertising and what is an $8 CPM on The New York Times today turns into a $4 CPM, then the New York Times is going to be out of business. That’s what’s at stake.”

Less Repairable Cars

The research question at top of mind today is: how has Copart (CPRT), a “global leader in online vehicle auctions,” been able to grow revenues far faster than GDP growth over the last ten years?  It has increased market share in its most mature market, the U.S.  It has entered new markets: UAE, Brazil, Germany, and Spain in 2013; Bahrain and Oman in 2015; Ireland and India in 2016, and Finland in 2018.

Yesterday’s quarterly earnings conference call though revealed an additional factor–“less repairable cars.”

As they say:

“Repair costs, particularly for new cars, are trending now at a rate exceeding that of inflation. An increase in the number and the average cost of replacement parts, the growth in pre and post repair scans and the supplemental damages they’re identifying, the lack of capitalized repair capacity and the consolidation of the repair market by the three major MSOs are all leading to a rise in repair cost. We believe the industry is simply trending to less repairable cars.”

Higher repair costs push insurance companies to declare more vehicles as total losses.

“Organic growth in the salvage market is driven, we believe, by an increase in total loss frequency. Published statistics suggest a total loss frequency of 19.9% for the first quarter of calendar 2019, an increase of 2.6% over the same quarter last year.  This metric measures the percentage of estimates written that result in total losses. What is not reflected in this metric is the increase in the instances in which insurance companies salvage cars without ever writing a repair estimate.  Our conversations with insurance company executives as well as the current trends and assignments lead us to believe that the growth of total loss frequency is higher than that published.”

If this analysis is correct, one would expect to see a variety of secondary and tertiary effects show up in related industries over the next decade–at the very least, among auto insurers, automakers, and auto parts purveyors.

On Taxing Duties

Mark 2017 as the year that voting rights began to matter once again.  The trend began many years past with the separation of share classes, and it imagined an inevitable future in which equity ownership was docile, impotent, and utterly passive.

Exhibit A of our new dawn was the IPO of Snap’s voteless shares.  Following the observed path of its tech brethren–Google, Facebook, et al.–it tried to do one better.  Why yield public investors any votes at all?  For its youthful boldness, the index overlords exacted their punishment, thereby abandoning it to that lurking nemesis from over the sea.

Let Exhibit B be the thinly veiled boardroom battle at Uber.

And for Exhibit C, I present Liberty Tax (Nasdaq: TAX), controlled by founder and “former CEO” John Hewitt.  Amid this particular boardroom battle, Mr. Hewitt’s voting rights have afforded him delicious privilege.  Namely, the privilege to “[engage] in an array of inappropriate conduct, both personally and involving business matters, while serving as Liberty Tax’s CEO and Chairman,” and continue to control the company despite the Board’s attempts to terminate him.  In this case, when the dust ultimately settles, Liberty will have lost the service of at least four Board members and two company executives.

Take sides as you must, but do pay homage to the personal sacrifices demanded by the skirmishes of this grand conflict.

On this day may Liberty’s minority shareholders yield gratitude for John Garel’s service.

Disclosure: No position.

Joe Papa Gets Paid(?)

If a tree falls in the woods, does it make a sound?

If Valeant’s stock falls to $11 per share, did he really get paid?

The WSJ ran an article yesterday detailing the 2016 compensation of Valeant’s CEO Joe Papa.  I suppose the Editor’s thinking ran something like this: 1) its proxy season, 2) I’ll task an intern to find high CEO compensation even though the company’s stock price is low, 3) provoke reader outrage, 4) bring in the eyeballs, and 5) … profit?

Seems a decent strategy and allows abundant storylines.  It teases with envy.  It challenges the scales of justice and that old yarn about “pay for performance.”  Mark this reader intrigued–they hooked me.

Of course, when I looked at the proxy, the evidence there made it difficult to sustain that “Valeant (VRX) CEO Joseph Papa made $63 million in pay last year, according to documents the former pharma darling filed Thursday with regulators.” (CNN)

Yes, p. 57 does show that neat table with the Total Compensation figure — $62,717,846.  Case closed, right?

Perhaps, if you are that brand of journalist who tweets, baits clicks, and makes myths.

Yet, in this case, the proxy notes reveal some truths that may be even more interesting than standard fiction.

Of the $62.7 million, $8 million was “to compensate [Papa] for equity-based compensation he forfeited in connection with the termination of his employment with Perrigo.” (54)

$52 million of his compensation was comprised of stock and option awards.  And there are three components: PSUs (performance stock units), RSUs (restricted stock units), and options.  All vest at various intervals over the four remaining years of Papa’s current contract.

Interestingly, the 933,416 PSUs (valued at $29.8 million) “will vest on the fourth anniversary of the commencement date based on the achievement of the following share prices… : (a) if the share price on the vesting date is below $60, none of the PSUs will vest…” (54)  Suffice it to say that a share price of $60 is a long way from today’s $11.

The 373,367 RSUs (valued at $12.1 million) “will vest on the fourth anniversary of his commencement date subject to Mr. Papa’s continued employment through the vesting date…”  Four years is a long time in public equity markets, but suffice it to say that $VRX needs a much higher stock price than today’s to reach the RSUs’ imputed value.

Lastly, the 682,652 options (valued at $10 million) “will vest as to 25% of the total award on each of the first four anniversaries following the commencement date, subject to Mr. Papa’s continued employment with the Company through the applicable vesting date.” (55)  Since the strike price on these options is $23.92, Mr. Papa again has some serious work to do to realize any compensation from these.

As an additional footnote, recall that “Mr. Papa was required to purchase $5,000,000 worth of Common Shares by no later than the first anniversary of his commencement date. Mr. Papa has satisfied this obligation.” (54)  Based on his disclosed share count (202,000), it seems Mr. Papa paid roughly $24.75 per share for his initial stake.  Papa’s first year of employment then was rather expensive for someone “paid” so much; that fickle Mr. Market dinged him roughly $3 million for his “show of confidence.”

All in all, I will not disagree–Mr. Papa will do very well for himself if Valeant’s stock price ascends above $60 per share.

Of course, if that price stays around here, or if it only manages to double in the next four years, it would seem that Mr. Papa was not actually paid his $62.7 million after all.

Disclosure: No position.

Warren Buffett Loads Up on Apple

So… I guess you’re telling me it’s over.apple

Alice Schroeder’s opus The Snowball recalls a story about Benjamin Graham, Warren Buffett’s teacher and mentor.  The year was 1956, and Ed Anderson–a chemist who liked to coattail Graham’s investments–walks into the Graham-Newman office.

“Anderson had come in because he was thinking about buying another share of Graham-Newman, but he had noticed an oddity and he wanted to ask about it.  Graham had loaded up on shares of American Telephone & Telegraph.  It was the least Graham-like stock imaginable–owned, studied and followed by all, valued fairly, with as little potential as it had risk.  Was something going on? he asked Warren…

From watching the firm’s trading patterns and keeping his ears open, [Warren] had already figured out that Graham was going to shut down his partnership.” [199]

Fast forward to 1968… After a epic run managing the Buffett investment partnerships (a “1 in 1 billion event”), the last chapter of that story eerily finds Buffett also purchasing shares of “the blandest, most popular stocks that remained reasonably priced: $18 million of AT&T…” [316]

Of course, the clearest analogue to yesteryear’s AT&T has to be today’s champion and market behemoth–Apple.  To note on this day that Buffett has loaded up on 40 million shares of $AAPL leaves this investor with a sense of foreboding…

If the pattern is to repeat, I guess something has now reached an end.

Disclosure: As of today, I am long Berkshire Hathaway shares and short call spreads in Apple.

Pioneer Energy Services Unsecureds

Today’s post repeats many of the themes from our last.  A company in the energy sector?  Check.  Plenty of unsecured debt outstanding?  Check.  Unsecured trading substantially below par?  Check.  Revenues down nearly 50% YoY?  Check.  No signs of relief on the horizon… check.

“Pioneer Energy Services Corp. provides drilling services and production services to a diverse group of independent and large oil and gas exploration and production companies throughout much of the onshore oil and gas producing regions of the United States and internationally in Colombia. We also provide two of our services (coiled tubing and wireline services) offshore in the Gulf of Mexico.” (latest 10-Q)

Pioneer has a secured $350 million Revolving Credit Facility with Wells Fargo at present, with $110 million outstanding as of 7/30/15 and $21.3 million in committed letters of credit.  Borrowing availability as of July 30th was $218.7 million, and Pioneer was in compliance with all the covenants under the facility, which matures in Sept 2019.

Pioneer also has $300 million of senior notes outstanding which bear a coupon of 6.25% that mature in March 2022.  These notes Mr. Market currently values at roughly 60 cents on the dollar.  Similar to Cloud Peak, the market value placed on Pioneer’s unsecured debt is less than the availability on their credit line.

On the equity side, Pioneer had 65.5 million shares outstanding as of July 15, 2015.  After talking a $71 million pre-tax impairment charge in Q215, the company has a book value of $406 million at 6/30/15.  At today’s $3 per share price, Mr. Market values the equity a bit below $200 million.  (For those so inclined, it would appear there is no cost to borrow.)

Pioneer does have some capex commitments for the remainder of the year, roughly $65-75 million, to acquire “five new-build drilling rigs, nine well servicing rigs, eight wireline units, routine capital expenditures and certain drilling equipment which was ordered in 2014 but requires a long lead-time for delivery.” (30)  Pioneer did show $63 million in cash on the balance sheet at 6/30/15, and they are actively marketing some idle rigs for sale.

In the recent Q215 results conference call, management candidly described the challenges for Pioneer in this low energy price environment:

“…it is a soft market and there is not a lot of demand, there is not a lot of demand in drilling. And I think that it’s building for a definite recovery probably beginning in 2016 if not at the end of the year, but it’s probably going to be slow and we have got to manage our business as if it’s going to be slow and lower for longer and keep our cost structure tight and that’s what we intend to do.  So, I think we are anticipating a little bit more pain in the third quarter…”

Not exactly a ringing endorsement.  As Dr. Michael Burry might say… ick.

Disclosure: I own some of Pioneer’s 6.25% 2022 unsecureds.