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Morningstar | Knight-Swift’s Rate Backdrop Will Moderate in 2019, but Progress at Swift Continues.

In the fourth quarter, Knight-Swift’s revenue before fuel surcharges increased 2% year over year, in line with our expectations. Relative to the same period last year, the firm's combined full-truckload shipping operations benefited from robust contract pricing gains throughout 2018, driven by historically tight truckload-market capacity. These factors were partly offset by a lower average tractor count at Swift associated with ongoing optimization efforts in Swift’s for-hire truckload and refrigerated units. Recall Knight Transportation and Swift Transportation merged in September  2017. The legacy Knight division enjoys a long history of industry-leading execution and management has been working diligently to bring Swift’s performance more in line with Knight’s standards. In our view, the firm has made good progress over the past several quarters. Overall, we haven’t materially altered our midcycle revenue and margin assumptions, but we expect to raise our $35 fair value estimate by about 3% on the time value of money since our previous update.

Throughout 2017 and the first half of 2018, Knight’s shares traded in highly overvalued territory. That said, valuations across the trucking space eased in the second half as investors recognized the historically robust pricing backdrop had peaked and 2019 would usher in more modest growth trends for truckers. Knight’s shares sold off slightly more than the rest, in part because of concerns over Swift’s lackluster refrigerated-segment performance, but the stock has since recovered a bit, especially following today's earnings release, which showed continued progress. As of market close on Jan. 29, the shares are trading in fairly-valued territory. Looking ahead, we don’t expect Knight’s operating backdrop to fall off a cliff, but overall top-line growth trends will moderate significantly in 2019 as the truckload capacity crunch is easing--this dynamic has long been baked into our fair value estimate.

The legacy Knight Transportation trucking-segment posted another solid quarter on lingering tailwinds from highly favorable contract pricing conditions in 2018. Revenue before fuel surcharges was up 27%, reflecting a 11% increase in core revenue per mile and 2% improvement in miles per tractor. Legacy Knight’s average tractor count expanded 8%, contributing nicely to top-line growth, but we suspect most of that stems from the first-quarter 2018 Abilene Motor Express tuck-in acquisition. Knight’s legacy trucking segment and its asset-light highway brokerage division both posted solid operating ratio (expenses/revenue before fuel) improvement on the back of higher core pricing.

Swift-segment total revenue fell about 5%, as the impact of a lower average tractor count (linked to optimization efforts) more than offset intermodal-segment growth and pricing gains across its trucking divisions. That said, progress on the operational-optimization front continued, and Swift’s total adjusted OR improved more than 500 basis points year over year.