valuexvail 2013 - guowei zhang

7/28/2019 ValueXVail 2013 - Guowei Zhang

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Pennypack CapitalPacer Internatio nal (PACR)

For ValueX Vail 2013

Contact:Guowei ZhangManaging [email protected]


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Introduction

Pacer is an asset-light 3rd party logistics company focusing on

intermodal transportation

$220M market cap; $195M enterprise value

2012 Summary: $1.4B revenue; $9M of EBIT

Intermodal is the movement of goods via different modes of

transportation truck and rail

3rd largest intermodal marketing company in the U.S.

Customers: Big Lots, Costco, Ford, P&G, Toyota, etc.

Investment Thesis: Substantial margin improvementopportunity in a secularly growing industry

An attractive ultralong-term investment


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Introduction (Continued)

Simple illustration of intermodal transportation

Shipper ReceiverOrigin

DrayagePacer

responsible forpickup

Delivery to railintermodal

terminal

Equipment:minimal

Partners:drayage

companies,independent

owner-

operators

RailroadDestination

DrayageTransportation by Railroad

Pacer buys capacity from railroads

Equipment:Containers & Chassis (leased)

Containers (provided by railroads)

Partners:

Railroads

Pacerresponsible for

pickup fromrail intermodal

terminal

Delivery to

destination

Equipment:minimal

Partners:drayage

companies,independent

owner-operators

Pacer Takes Care of Everything in Between

Pacer sells itsservices toshippers

Providestracking

capabilities

and othercustomerservices


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Introduction (Continued)

(Figures in Millions)

Segment Revenue: 1,180$ 238$

2012 Segment EBIT (1): 38 (10)

Business Description:

Capital Intensity: Low Low

have operating leases have operating leases

(1) Does not include $19M of corporate and unallocated expenses

International and

domestic intermodal

services. Include

Mexican cross-borderintermodal services.

International freight

forwarding,

warehouses, ports &

transloading services,highway brokerage.

Intermodal Logistics

Two business segments


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Investment Thesis

Solid secular growth story for the next decade and longer

Strong business model with economies of scale

Low asset intensity

Substantial margin improvement story in Intermodal

Low valuation: nearest competitor is twice the size of PACR inrevenue, but trading at 7x enterprise value

Potential short-term & long-term catalysts

High ROIC business with substantial margin improvementopportunity in a secularly growing industry

An attractive ultralong-term investment


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#1: Solid Secular Growth Story

Intermodal volume grew at a 5.8% CAGR since 1980, much

faster than rail and trucking volume

Forecasted volume and revenue CAGR of 4.7% and 8%,respectively

Source: ATA, IHS Global Insights, Norbridge.


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#1: Solid Secular Growth Story (Continued)

Intermodal is only 2% of the overall transportation industry

($13B market). Meaningful opportunity for penetration

Trucking still represents 80% of the overall transportation market.Intermodal has been and will continue to take share from trucking

Intermodal transportation is 10-20%cheaper than trucking and

has a lower carbon footprint

Rail is 3x-4x more fuel efficient than trucking

Just one long-distance, double-stack train between Chicago and LosAngeles can save 75,000 gallons of fuel by replacing 300 trucks, each

traveling 1,983 miles. Trucking cost continue to go up, which will support market shift

towards intermodal; road congestion is getting worse

Tighter regulation, labor shortage and environmental concerns willcontinue to increase trucking operating cost


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CSX believes intermodal investments will expand

addressable market in eastern U.S. by 150%; totalintermodal opportunity of 20m units in the U.S.

Piggybacking off of massive railroad investments

Greenfield and expansion of rail intermodal terminals; conversion of

routes to double-stack

In total, the railroads are spending approximately 17-18% of revenue incapital expenditure ($14B), a large portion of which is to expand theirintermodal networks

Investments by federal and local governments on top of railroad

investments

These investments open up substantial new markets for intermodal

More reliable service attracts new customers switching from trucking

Deeper penetration of intermodal terminals opens up new markets


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Intermodal is competitive around 800-1,000 miles, but as

trucking costs go up, the breakeven point is declining

Source: Norbridge.


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Gradual market shift from trucking to rail as service level

and penetration improve

Currently still a significant portion of transportation over2,000 miles done via trucking!

Source: ATA, IHS Global Insights, Norbridge.

%o

fMarketShare

Current Truck Market

Current Rail Intermodal Market

Projected Market Shift


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#2: Strong Business Model

Natural economies of scale through asset utilization.

As revenue grows, margin should structurally improve

Illustrative

Business Model Where is Economies of Scale?

Number of Containers 18,000 More containers means better customer service and full er coverage:

PACR has the 3rd largest fleet in the industry

Container Turn Per Month 1.80 Key driver of profitability is how well containers are utilized.

Total Intermodal Revenue 1,180

Cost of Goods Sold as % of total cost

Rail Cost ~50% 571 Better contracts with rail carriers means better ul timate service for

customers (priority loading, etc.) and potentially lower cost

Drayage (trucking) Cost ~25% 285 Key driver of profitabil ity: Optimization of trucking operations and

density dictate margins

Container/Equipment Cost ~10% 114 Container usage optimization improves margins

Other Cost 107 Network balance, etc.

Total Cost of Goods Sold 1,078

Gross Profit 102

Gross Margin 8.7% LOW MARGIN BUSINESS. SUBSCALE PLAYERS CANNOT COMPETE.

SG&A 64 Substantial SG&A leverage.

EBIT 38

EBIT Margin 3.3% LOW MARGIN BUSINESS. SUBSCALE PLAYERS CANNOT COMPETE.

Note: Unit economics based on 2012 figures. Does not pro forma for the new Mexico auto contract .


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#2: Strong Business Model (Continued)

An example of economies of scale in in-house drayage to

remove empty miles

Non-optimized DrayageIn-House Drayage with

Network Density

This type of economies of scale also occurs in lane density andequipment utilization (balanced box flows, empty box repositioning,chassis utilization)


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#2: Strong Business Model (Continued)

price is not our only weapon that we have here in order to become more efficient and

expand the gross margins. We can also do it through operating efficiencies. We can do itthrough better balance within our dray network. We can do it by handling more of our own

drayage. We can do it by better turn times.

- HUBG CEO on efficiencies, 1Q 2013 earnings call

There are some new players. This is a business of scale and scope and understanding

how to effectively operate in an intermodal environment. It's not a simplistic thing for a newentrant. So the vast majority of the competitive environment is driven by the traditionalplayers. And again, we include ourselves in that. And one other large provider we think iskind of -- are the 2 largest in the space and I think, at this point, the most efficient. And soagain, it's just -- it's difficult for a new entrant with a 1,000 or 2,000 containers to really domuch of anything because you can't necessarily market that. It's not a large enough networkto have much of an impact on your customer base

- HUBG CEO on competition, 1Q 2013 earnings call

Good economies of scale due to fragmentation of

shippers, origins, destination, fragmentation of truckersand the need for asset/network optimization


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#3: Margin Improvement Story

Pacer is substantially underperforming its nearest

competitor in margins

(Figures in Millions)

Revenue: 1,180$ 2,392$

Gross Margin: 8.7% 11.0%

EBIT Margin (3): 1.9% 4.1%

(1) Only intermodal division.

(2) Does not include the Mode division. Results also include truck brokerage and logistics.

(3) PACR: Assumes corporate SG&A allocated on a revenue basis.

PACER(1) HUB (2)


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#3: Margin Improvement Story (Continued)

Scale and business mix explain some of the margin

differential

Business Transformation: Transitioned from wholesale Mostly retail operation

to retail only recently (2010).

Moving up in the value chain.

Wholesale Retail

PACER HUB


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Scale and business mix explain some of the margin

differential

Scale: Need to continue to build HUB is effectively twice as large

retail salesforce as transition as Pacer in intermodal

to retail is new

Business Mix: Strong in transcon and HUB is 1/3 local east, which means

north/south. faster container turn

Weak in local east Box turn is 2.4

Box turn is 1.8

Rail Cost: NA HUB may have cheaper rail

contracts due to size??

Drayage Cost: NA Because of size, has better

density for trucking, which minimizes

empty miles

Equipment: Leases containers Leases and owns containers.

PACER HUB


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Management wants to get to HUBGs margin levels and is

active in improving margins.

Sales: Aggressive at reducing low margin business.

Rail: Working collaboratively with rail partners to bid for new business

This improves pricing vs. rail cost visibility

Dray: Improve carrier mix

Improve street efficiency

Accessorial management

Equipment: Improve equipment utilization

Network: Improve network balance

SG&A: Aggressive at controlling SG&A

Lean processes

Margin Improvement Actions


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Pacer and HUB both focused on getting better pricing

The decline in domestic revenues is mostly a result of our efforts in the second half of last year to

pare low-margin freight that we had won in the first half of that same year, but later becameunattractive due to large unexpected rail cost increases in Transcon lanes. As we described in boththe third and fourth quarters of last year, we repriced much of that business and as a result, someof that volume went away. Additionally, our approach to this year's bid season has been to be very

disciplined in our pricing.

- PACR COO, 1Q 2013 earnings call

We certainly saw some business in which we were the incumbent, that went out to the market andcame back at prices that were simply not compensatory for us. And it's hard to walk away frombusiness, but the right answer isn't always yes. Sometimes the right answer is no, contrary to whatmany of our sales people believe.

- HUBG CEO, 1Q 2013 earnings call


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Margin improvement is starting to show up in the results,

but 2012 is an easy comparison

-2.5%-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013

YoY Margin Changes

GM YoY Chg. EBIT Margin YoY Chg.

Margins were substantially depressed in 2012 due to mismatch of railcost vs. pricing (more on this later)


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#4: Low Valuation

Headline valuation is misleading as it includes losses

from the Logistics divisionValuation

Headline Excluding

Valuation Logistics (1)(2)

2012

EV/EBITDA 11.3x 6.4x

EV/EBIT 21.0x 8.6x

P/E 53.0x 17.0x

2013E

EV/EBITDA 7.8x 5.6x

EV/EBIT 11.0x 7.1x

P/E 20.6x 13.3x

Normalized FCF Yield (3) 6.0% 8.7%

(1) Assumes corporate costs are allocated into segment results based on segment revenue.

(2) Assumes tax rate of 40%.

(3) Exclude 1x working capital benefit in 2013.


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#4: Low Valuation (Continued)

Logistics division is undergoing a turnaround. A

perennial money loser that should be divested ifturnaround is not successful

2005 2006 2007 2008 2009 2010 2011 2012 2013E

Revenue 458 397 402 456 386 422 304 238 232

Segment EBIT 5 2 4 (0) (4) 1 (2) (10) (7)

Managements rationale for keeping Logistics division:

Logistics division completes Pacers comprehensive service offering

New management and sales force hired. Needs time for turnaround

My take:

Logistics division has very little synergy with Intermodal

A low-cost option on the turnaround: currently no value is assignedto the Logistics division. Low capital intensity business that does notcost much to wait for an eventual turnaround.


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#4: Low Valuation (Continued)

Pacer trades at a substantial discount to HUB. Current

valuation seems to assume no margin improvementpotential. I believe that Pacers valuation will increase

once execution is provenPacer

Excluding Pacer

Logistics (1)(2) HUB Discount

2012EV/Sales 0.16x 0.43x -61%

EV/EBITDA 6.4x 9.9x -36%

EV/EBIT 8.6x 11.8x -27%

P/E 17.0x 19.9x -14%

2013E

EV/EBITDA 5.6x 8.9x -37%

EV/EBIT 7.1x 10.5x -33%

P/E 13.3x 17.4x -23%

Normalized FCF Yield (3) 8.7% 5.9% -33%

(1) Assumes corporate costs are allocated into segment results based on segment revenue.

(2) Assumes tax rate of 40%.

(3) Pacer: normalized for 1x working capital benefi t. HUB: normalized capex.


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#5: Short-Term Catalyst

Divestiture of Logistics division if turnaround is

unsuccessful

No value is currently assigned to the Logistics division

A potential divestiture, even for a nominal amount, will be beneficialto Pacer

Focuses managements attention on the Intermodal division

Eliminates near-term P&L losses

Improves headline valuation

But would be much better if the turnaround is successful!


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#5: Long-Term Catalyst

Economies of scale motivates greater industry

consolidation. Would not be surprised if M&A activityoccurs

Rationales for industry consolidation

Greater and more flexible asset base provides better customer service

Greater economies of scale, better efficiency, better margins

Greater negotiating leverage with railroads and customers

Less industry competition


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Investment Thesis Summary

A combination of positive forces

Steady secular growth

and penetration of

intermodal

8% Revenue CAGR

Structural improvement

in margins due to

economies of scale

Good Moat

Potential improvement

in intermodal margins

Doubling of

margins?

Valuation improvement due to better execution

Closing of value gap Between HUB and Pacer

Near-term catalyst

Divest Logistics;

or success in its

turnaround

Long-term catalyst

Industry

consolidation


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Investment Risks

Industry risks

Ability to pass on rail and trucking cost increases

Railroads as good partners?

Cyclical business; high operating leverage

Independent contractors vs. employees in drayage operations

Company specific risks

Substantial execution risks in margin improvement

Failure in turning around the Logistics division

Lack of exposure to local east intermodal market, which is growing rapidly

Lack of clarity in new auto contract with UNP; exposure to the auto industry,which represents 40% of total sales

Panama canal expansion in 2015 and potential traffic shift to the eastern U.S.market, where Pacer is underrepresented

Tumultuous company history

Right industry, but wrong company?


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Risk #1: Ability to Pass on Cost Increases

In 2012 intermodal marketing companies operated in acompetitive bidding environment and lost margins due to theinability to match pricing with rail cost increases

Rail and trucking costs expected to increase for the foreseeablefuture due to the need to generate an attractive ROI on railinvestments and higher labor and equipment costs for truckers

Mitigating factors:

Industry is becoming more concentrated. Top 4 now represent closeto 50% of the overall intermodal market

Participants are disciplined and are giving up low margin business

Railroads are looking for intermodal to grow (now 40% of total railvolume) and will adjust pricing to drive volume

Can Pacer pass on rail and trucking cost increases to

customers?


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Risk #2: Railroads as Good Partners?

UNP is Pacers rail partner in western U.S. Pacer leases UNP

equipment. UNP accounts for the majority of Pacers rail costs

UNP and other railroads have their own intermodal marketingoperations that sometimes compete with Pacer

Railroads offer container capacity to the intermodal industry

Railroad performance may suffer

Mitigating factors:

Railroads are highly dependent on intermodal for growth Railroads intermodal marketing operations are more wholesale

focused. They lack national coverage and are dependent on retailintermodal marketing companies for business

Potential forward integration is not likely given railroads historical

failure at retail intermodal. Minimal experience in sales

IMCs are highly dependent on their rail partners


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Risk #3: Cyclical Business, High Operating Leverage

HUB revenue fell 20% in 2009. EBIT margin down 140bps

Pacer revenue fell 27% in 2009, although part of this was due tothe wholesale to retail transition

Mitigating factors:

Transportation industry is highly cyclical. High operating

leverage introduces sharp volatility in earnings

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Pennypack Recession Indicator - Leading

Recessions Indicator


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Risk #4: Independent Contractors vs. Employees

Most of the drayage operations is currently performed byindependent owner-operators

Change to employee status will require a change in financial and

business model more capital intensive, but offset by bettermargins

Different risk and liability profile

Mitigating factors:

Short-term disruption, but doesnt take away from the industry story

Eliminates small competitors

Government authorities may assert that independent

owner-operators are employees


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Risk #5: Substantial Execution Risks

Pacers transition from wholesale to retail operations occurred

recently. Completion only happened two quarters ago with the

new Mexico auto contract Management team is unproven in execution

Mitigating factors:

Taking the right steps so far

Current valuation doesnt assume margin improvement

Transition from wholesale to retail operations was painful.

Can Pacer improve margins? What happens if Pacerdoesnt improve margins?


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Risk #6: Failure in Turning Around Logistics

Logistics division is subscale

Undergoing its own transition from wholesale to retail in theinternational freight forwarding business

New management and sales team need time to turn leads intorevenue

Failure in turning around operations will result in poor headlineand short-term profitability impact

Mitigating factors:

Management will shut down or sell the division if turnaround is notsuccessful

Failure in turning around the Logistics division will impact

short-term earnings


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Risk #7: Lack Local East Exposure

Local east is growing rapidly due to railroad investments to openup secondary markets. This is a huge growth opportunity thatPacer is currently missing out on

Pacers local east offerings are not competitive given low drayage

density

Mitigating factors:

This also represents a large opportunity for growth. Current salesforce is not adept at converting trucking customers to intermodal.

Need substantial dedication in sales effort Although Pacer is weak in local east, it is very strong in north/south

lanes, which will take advantage of huge growth in near-shoring andthe Mexican cross-border market

CSX, Pacers eastern rail partner, may lower rail costs to improve

intermodal volume, which benefits Pacer

Pacers local east business is small and not competitive


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Risk #8: Lack of Clarity on New Auto Contract

New Mexican auto contract changes the role of Pacer from awholesale intermodal marketing provider to a network manager

for UNPs auto business

Although margin contribution will be the same in 2013, future revenueand profitability is uncertain

over the remaining term of the agreement, our revenue and margin

for the services and equipment provided under the agreement declineabsent growth in our retail direct US-Mexico business - Pacer 10Q

Mitigating factors:

New contract allows Pacer to sell directly to intermodal customers,which was generally not feasible under the old contract

Allows management to offset any potential drop in revenue specifiedin the contract with new Mexican cross-border business, which is

growing rapidly

The recently renegotiated Mexican auto contract with UNP

lacks details


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Risk #9: Panama Canal Expansion

Doubling of Panama Canal capacity by 2015

Benefits east coast ports and reduces demand for west coastports

Mitigating factors:

Its up to the railroads to make intermodal transportation competitive.

UNP plans to protect its intermodal franchise

This may involve the reduction of rail pricing to offset any potential

drop in demand

Panama Canal expansion will shift volume to the local

east market, which is not Pacers strength


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Risk #10: Tumultuous Company History

Painful transformationwhats different now? Is this the

wrong company in a good industry?

Explanation:

Renegotiation ofbelow-market UNPcontract in 2009

Transition to retailand loss of allwholesale business

Difference now:

Delevered

substantially. Nowin net cash position

Transition to retailcomplete

Cleaner story

valuexvail 2013 - guowei zhang

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