Knight-Swift Transportation - Further M&A, Further Growth

Jan 9, 2022
Knight Transportation Truck rijden op de snelweg

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Knight-Swift Transportation (KNX) has been doing alright since its mega deal which dates back to 2017 when Knight Transportation acquired Swift, even as its own business was quite a bit smaller. On the back of strong economic growth and deleveraging, the company has been pursuing more deals as of recent. These deals look compelling as momentum has been very strong in 2021, as it seems that there is still some appeal left in the shares.

A Look Back - Setting Expectations

My last take on Knight-Swift dates back to Mach 2018, half a year after the deal between both companies had closed. Shares of Knight jumped aggressively to $35 at the time of the deal announcement in 2017, after which they rallied to $50 in spring 2018 with the initial signs of integration looking quite solid.

The rationale was that Knight would discipline Swift to the same standard at which Knight operated. The deal was quite ironic of course. Knight posted just $1.1 billion in sales on which nearly 15% operating margins were reported, while Swift was far greater with some $4 billion in sales, yet its margins were stuck at just around 7%.

The deal was set to result in synergies of $150 million by 2019, as the realization of synergies should drive earnings from $1.30 per share to $1.85 per share in 2019, resulting in real accretion as I understood why shares rose to $35 on the back of the announcement. The deal closed in September 2017 as shares rallied to the $50 mark with the fourth quarter results for 2017 implying that earnings trended at $2 per share already. Leverage at just below $900 million was a very reasonable amount with EBITDA trending at $800 million already.

Pegging a roadmap for earnings to increase to $2.50 per share in 2019, I thought the $50 per share valuation might be justifiable, yet it left no room for error as I waited for dips.

The Dip Came

After being fairly constructive on Knight in 2018 the dip arrived soon as shares fell to the $30s that summer, to end the year in the mid-twenties. I got filled on some orders and initiated a position at an average of $35, a bit too soon of course.

The reason for that is that momentum faded in the marketplace. While revenues of $5.3 billion, operating earnings of $569 million and net earnings of $2.36 per share for the year 2018 were quite solid, and in line with my expectations, the market was in for a reversal. 2019 sales fell to $4.84 billion, as operating profits fell to $427 million as earnings fell to $1.80 per share, in some part offset by some share repurchases. Net debt has already been down to $500 million, yet the business was in need of some reorganization, to combat the intense competition and softer demand as well as increased supply coming online.

Ahead of the pandemic the company guided for a modest recovery for the year 2020, with earnings per share seen between $2.00 and $2.15 per share. That was of course ahead of the pandemic as a stronger second half of the year made that the revenue declines of just 3.5% were quite modest, with full year sales reported at $4.67 billion. Operating earnings improved from $427 million to $564 million, with a lower fuel bill being a major contributor.

Amidst a continued decline in the share count and a big improvement in margins, earnings improved from $1.80 to $2.40 per share, with adjusted earnings coming in as high as $2.73 per share. Net debt has been cut to $300 million, a minimal amount with EBITDA having improved to $1.1 billion.

The 2021 guidance called for earnings to improve to $3.30 per share on an adjusted basis. With shares trading in the mid-forties at the start of the year, it goes without saying that multiples were not that demanding.

Strong Recovery

While the original 2021 guidance was quite solid, the company only has seen further momentum since the start of the year. Following the first quarter earnings report, Knight raised the midpoint of the full year guidance to $3.525 per share. The guidance was further hiked to $3.975 per share alongside the second quarter earnings release as this gives management could some confidence, with the company announcing a big deal just ahead of this report.

In July 2021, Knight announced the purchase of AAA Cooper Transportation, an LTL carrier which is set to add some $780 million in revenues, $140 million in EBITDA and $80 million in operating income. The deal came at a $1.35 billion deal tag, at 1.7 times sales and nearly 10 times EBITDA. Following the third quarter earnings report, Knight even hiked the guidance to $4.525 per share, up significantly above the original guidance for the year.

Net debt has jumped to $1.35 billion, as a result of the AAA deal. EBITDA already totaled $1.05 billion for the first nine months of the year, which makes that leverage comes in around 1 time, still very manageable as EBITDA for 2021 will likely exceed net debt.

This has been pushing shares higher towards the $60 mark in November, and now shares trade at $58 per share. This values equity at $9.7 billion, or the entire business at $11 billion. Such a valuation is equivalent to roughly 2 times sales, or actually a bit less with revenues likely seen around $5.7 billion excluding the AAA deal, and thus $6.5 billion including that deal, for a 1.7 times sales multiple. Leverage likely trends around $1.5 billion per annum, implying that Knight trades around 7 times EBITDA.

Just before year-end, another tuck-on deal was announced. Knight-Swift announced the purchase of Midwest Motor Express, an all-round transportation service provider. The $150 million purchase price translates into a 1.1 time sales multiple based on $137 million in revenues. That said, the business is quite profitable as the $27 million EBITDA contribution comes in at less than 6 times while the operating income contribution of $16 million reveals a less than 10 times multiple paid on that metric. This means that at least six cents in earnings per share accretion is expected, with more to come following the integration.

Final Thoughts

With earnings now comfortably running above $4.50 per share, the current multiple comes in at just 13 times. This is a modest valuation, as leverage only comes in at 1 time EBITDA, despite a substantial deal for AAA this past summer. Hence, I think there is much to like about Knight, although that margins come in above the long-term trend. Nonetheless, the valuations look quite reasonable here as I am not in a dire need to expand the position, but certainly feel comfortable to hold onto the position.

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