EUR 850.00 For Business Accounts Only

Morningstar | KNX Updated Star Rating from 25 Oct 2018

In the third quarter, Knight-Swift’s total revenue before fuel surcharges increased to $1.2 billion from about $470 million, mostly thanks to the September 2017 merger of truckload industry leaders Knight Transportation and Swift Transportation. We estimate total pro-forma revenue, net of fuel surcharges, increased 3%. Operating conditions across the full-truckload industry remain highly favorable, with solid demand growth (positive macroeconomic trends) and historically robust spot and contract rate gains linked to unusually tight industry capacity. Pricing tailwinds are benefiting the legacy operations of both Knight and Swift, though the legacy Knight operations have been slightly better positioned to capitalize on that given a long history of industry-leading execution.

Since the firm’s overall performance is roughly tracking our expectations, we are maintaining our longer-term mid-cycle revenue growth and margin assumptions. We do not expect to materially alter our $35 fair value estimate. Market valuations for most of the truckload carriers we cover have come back down to more reasonable levels over the past few quarters, following almost two years of most names hovering in what we considered to be highly overvalued territory. We think easing market valuations stem in part from investors recognizing that industry growth trends, while robust, are peaking (especially in terms of core pricing, which will face very tough comparisons in 2019). Knight-Swift has the added overlay of uncertainty surrounding the achievement of merger synergies in the years ahead, which in our view has pushed the shares into modestly undervalued territory because of recent operational headwinds at Swift, including its under-performing  refrigerated division.

Driver recruiting remains a challenge, especially for the Swift segment, which once again grappled with unseated tractors (pressuring utilization) and the need to reduce fleet size—operating with fewer trucks reduces a truckload carrier’s ability to capitalize on a healthy demand backdrop outside of pushing up rates. We note that Swift’s refrigerated segment has also struggled over the past year, though management appears to be making progress stabilizing those operations—average revenue per tractor was up 6% sequentially, with 240 basis points of sequential margin improvement.

We expect truckload-industry capacity to remain tight throughout the remainder of 2018 due to healthy demand, the driver shortage, and widespread ELD adoption, which is tempering productivity for a large swath of the small-carrier base. This will likely keep the pricing environment healthy, though investors should be aware that year-over-year comparisons will turn increasingly difficult in 2019, even though absolute rate levels might remain elevated into the first half of the year. We also have confidence that Knight’s management team will adapt to the driver availability headwinds, while applying its best-in-class operating know-how (including cost and yield management) to Swift’s for-hire, dedicated, and refrigerated truckload network in the years ahead.

Knight’s legacy trucking-segment performed well in the quarter, with revenue (before fuel surcharges) up more than 30%, reflecting a 20% increase in core revenue per mile, 3% improvement in miles per tractor, and a 7% increase in average tractors, which enjoyed a boost from the first-quarter Abilene Motor Express tuck-in acquisition. Knight’s legacy trucking unit adjusted operating ratio (net of fuel surcharges) improved nicely to 77.8%, from 85.9% on the back of historically robust pricing conditions. Knight's legacy highway brokerage operations are also performing nicely thanks in part to strong spot-freight activity linked to tight capacity.