Monday, February 22, 2010

Pacer International (NASDAQ:PACR): The Price(ing) is Right; Upgrading to Buy; $8 target - BB&T Capital

BB&T Capital Markets is making a significant call in Pacer International (NASDAQ:PACR) upgrading the name to Buy from Hold and establishing a $8 target (prev. NA).

Firm notes their upgrade is predicated upon an improving intermodal environment, in particular pricing. While intermodal volumes have picked up for the first six weeks of the year, it is the talk of pricing that has us most excited about the Intermodal Marketing Companies (IMCs) and in today’s case Pacer. To be sure, we are just as enthusiastic about Hub Group (HUBG-$24.77- Buy) and J.B. Hunt (JBHT-$32.95-Buy). On the demand front, intermodal traffic is up 2.6% YTD compared to the same time frame in 2009. Containers on flat car (COFC) are up 5.3% YTD. Demand is nice, but pricing is the real leverage for an IMC and BB&T believes the Class I rails are looking to push across price increases in early spring (ahead of the April bid season) and then again in late summer/early fall. As a result, they believe intermodal pricing is finally headed in the right direction.

Talking about pricing. When the rails start pushing across price increases it makes the discussion that IMCs’ need to have with their shippers a little easier. When multiple parties begin talking about rate increases, it becomes more of the norm rather than the exception. After a couple of years of softening rates, BB&T believes 2010 represents a potential inflection point for intermodal rates. In fact, they believe rate increases are incurring faster than many industry participants anticipated and that includes both IMCs and shippers. Additionally, if truckload pricing turns positive, this should help support intermodal pricing. The past couple of years, rate reductions were standard and there was no way around it, but this year, they believe the tide will turn in favor of the IMCs and they believe that transformation is already underway. Rate hikes are like a snowball rolling downhill, when it starts happening, it is hard to stop and carriers want a piece of the action (of course it happens on the downside as well, when rates start falling it is hard to stop–the LTL industry is a great example).

What could the earnings look like for the new Pacer (i.e., without the wholesale business)? To be sure, BB&T believe Pacer is not going to earn $1.79/share like the company did in ’06 with record operating margins of nearly 27% (as a percent of net revenue), but can the company earn a $1.00/share in 2011? Every 1% improvement in intermodal revenue adds approximately $0.04–$0.05/share on an annual basis. Looking at the company from an operating margin (as a percent of net revenue) perspective, every 100 bps improvement adds
approximately $0.07–$0.08/share on an annual basis. BB&T's $0.60 estimate for 2011 assumes an operating margin of just 11%, and with a margin of 16.6% (well below peak), earnings are $1.00. With some of the cost savings that the company has implemented and a firming market, they believe it is quite possible that Pacer could earn $1.00/share in 2011.

A favorable risk/reward. In BB&T's opinion, they believe Pacer offers a compelling risk reward investment. The stock is trading at just $4.04 and has a tangible book value of $2.80, and as a result they see limited downside and with a lot of potential for upside. Firm notes they have been impressed with the new management team at Pacer and their focus on reducing costs, optimizing the network, and becoming more efficient. With purchased transportation costs on the rise with the new UNP agreement, management has been focused on cost reductions in other parts of the business, mainly SG&A.

Attractive valuation. Pacer is currently trading at 6.7x BB&T's 2011 EPS estimate of $0.60. Firm's $8 price target is based upon 13.3x their ’11 estimate. Historically, Pacer had traded at an average of approximately 16x one-year forward estimates. They acknowledge that a historical multiple is no longer reasonable in light of the loss of the company’s wholesale business and the uncertainty surrounding future profitability and therefore they have discounted the historical multiple approximately 20%. They believe it is worth noting that the company’s current level of debt at $27.8M is the lowest in history.

Notablecalls: PACR is going to fly high today, no question about it.

There is a lot to like about the call:

- It's Out-of-consensus, with BB&T calling higher rates & around $1 in EPS power.

- PACR is a long-forgotten name that has the ability to move big.

- Amazingly, valuation is still very low, allowing for a $8 target.

I suspect the stock can trade up 10-15% today, putting $4.40-4.60 levels in play. Note that the sector will be in focus today as Raymond James is upgrading Hub Group (HUBG) to a Strong Buy today.

It's going to get bid up big in the pre-market with very little shares actually crossing the tape. So I would be looking at the open for possible fills.

One to watch for sure.


ipbuyer said...

Does this analyst do any basic research? The new Union Pacific contract has higher railroad pricing which will hurt PACR margins. So even higher railroad costs are BAD for PACR especially since they can't transfer those increases to their customers (commodity business with no pricing power). PACR said on the call they expect their intermodal volumes to be down 20% in 2010 and pricing was -5 to -6% in recent quarter. How do you raise prices when volumes are plummeting and pricing environment is weak? And even if you do (in fantasy land), your own costs are higher b/c of new railroad contract? This sounds like a bad sell side analyst who was bearish before, making up reasons to chase the stock higher. Why not upgrade the day after earnings? So lame.

bl said...

Who's to know what goes on behind the scenes, imo. Charts do the talking: 5th 30 min candle was a nice buy for some.