Picking my spots for the End of Destocking: Heartland Express $HTLD

Finding excitement in a boring business

Hello and Welcome to another small cap value idea.  For those of you who have been following for a while, my largest logistics holding, Forward Air (FWRD), has been pressured by activist investors to go private and I will not be able to enjoy the stock returning to full value.  While still a double from the price when I first wrote about it, it easily could have been a two-year five-bagger.  But the thesis remains, we have been going through a prolonged destocking cycle, a longer and deeper destocking cycle than average, and at some point the highly cyclical logistics industry will go back to normal, or even boom times. This is also potentially a beneficiary of a Trump victory, as tariffs could reduce ocean freight but increase land freight.

I have found a new logistics company to start building a position to take advantage of the reversal of the logistics cycle, Heartland Express (HTLD).  Heartland Express is a 46 year-old, family-operated, midwestern trucking business which went public in the 1990s.  The grandfather and father of the current CEO had been in the business of buying trucking companies, fixing them, and selling them.  About 34 years ago, a smooth talking investment banker convinced the family that instead of selling their recent acquisition, they could sell half of it by taking it public, and keep on operating it afterward.  

Heartland Express positions itself in the trucking market as a high quality company, with a fleet of trucks with an average age of only 1.5 years as of the last time this metric was released.  HTLD prides themselves on service, they have been FedEx’s carrier of the year for the last 18 years, and last year out of 30,000 deliveries, only six were late. The extreme focus on the speedy replacement of equipment limits the extent to which the company can benefit from inflation as a tailwind.

Since 2019, HTLD has engaged in a buying spree, starting with the 2019 acquisition of Millis Transfer for $150 million, and followed by the 2021 acquisition of Smith Transport for $170 million.  Both of those acquisitions were paid for out of cash that came from the extreme profitability of the Covid lockdown era.  Then in 2022, HTLD acquired the assets of Contract Freighters Inc. (CFI), for $525 million.  This third acquisition made HTLD the 8th largest US truck fleet, but for the first time, gave the humble midwestern company long term debt.  By last quarter, that debt had been repaid down to $232 million, and heartland promised shareholders that all debt will be repaid within four years of closing the 2022 transaction.

Whenever I find an undervalued business, I always ask myself why the stock is underpriced.  Aside from the fact that small cap companies have been underpriced systemically for the last 20 years or so, the shareholder base of Heartland Express was very upset about the company taking on long term debt for the first time.  The promise to repay the debt within four years does not seem to have been enough comfort to satisfy their shareholder base.  Beyond that, all debt-fueled rollups have had their stock prices mercilessly punished in this rising interest rate environment.

Stock Price:

The current CEO, Mike Gerdin, son of the former CEO and the company founder, has four sons himself, and the older ones have expressed interest in working in the family business.  Mike Gerdin is 55, so keyholder risk is low, and since his sister, niece, brother-in-law, and son all work for the company, odds of selling the business outright are very low.  The patriarch of a clan can’t leave his family to the whims of a private equity firm’s discretion.

Beyond the debt-fueled rollup, Heartland Express has even been buying back a tiny bit of stock here and there, $7.3 million worth last quarter, and Mike Gerdin has been engaging in insider buying on behalf of himself and his mother’s family trust.  Between himself and the family trust, they own 31 million of the 78 million outstanding shares, or about 39% of the company.  It seems that his incentives are aligned for the long term growth of the family business, and shareholders are fortunate to be along for the ride.  Mike Gerdin has stated publicly that if the right opportunity comes along, he is interested in more acquisitions, and that acquisitions are an important part of Heartland Express’ history.

One of the largest challenges of doing a rollup is integrating the acquired companies.  Fortuitously, the prior strategy of buying trucking companies, fixing them up, and reselling them, has left Mike Gerdin with a lot of experience in this area, but still a relatively small company that has only just shifted to buying companies and keeping them.  It’s hard to imagine better fate than having someone experienced in fixing acquired companies, but still managing a relatively small business.  The digestion period for an acquisition to reach efficiency goals is about three years.  With the destocking cycle ending, and the digestion of acquisitions nearly complete, Mike Gerdin believes they can reach 85% Adjusted Operating Ratio within the next two years.  Think of adjusted operating ratio as the inverse of EBITDA margins, so about 15% of revenues should flow to EBITDA in normal times.  If 2023 was normal, normalized revenue of $1.2 billion could generate $180 million of annual EBITDA.  

Heartland Express’ multiple has been compressing and the stock price has been falling since 2014.  Even the dramatic over-earning during the Covid durable good pull-forward didn’t affect the stock price much. I believe the stock price will potentially move on three different tailwinds, the first is the end of the destocking cycle, which has already gone on for longer than most, a full two years.  And the second is that even if there isn’t a rotation to small capitalization companies, a rollup is on its way to escaping this low multiple trap, and mid caps aren’t nearly as beaten down as small caps.  Finally, if the share price has been compressed due to debt fears, then in two years when the debt is retired, that could be a catalyst for a return to prior multiples. 

Regarding capital allocation policy, I do not share the midwestern desire to be completely debt free.  If Heartland Express could lock in some low interest rate, long term debt, I think that leverage would be wonderful in an inflationary environment.  Mike Gerdin disagrees, and has been paying down roughly $25 million of long term debt each quarter.  This puts Heartland Express about two years away from being debt free again, or, the acquisition cannon will have been reloaded and ready to be used.  Mike Gerdin assures us that acquisitions aren’t done just for the sake of doing them, but are done opportunistically if the target is a good cultural fit for the company.  We will have to wait and see how the rollup progresses.  

The stock price doesn’t show any signs of having found a floor, so there is the risk that Heartland Express is still a falling knife.  The price has rebounded from the low in May of this year, but, GAAP net income was slightly negative last quarter, even though EBIT has recovered back into positive territory.  Odds are very good that Q1 2024 will mark the bottom for the fundamentals of Heartland Express, but we all know that prices can fall with improving fundamentals.  

Price to Sales Ratio:

Market Capitalization:

Shares Outstanding:

Gross Profit:

In the medium term, logistics companies regularly trade for a price to sales ratio of around 2.5x, which is where HTLD traded for most of its corporate history.  Today that number stands at 0.83x, and on depressed earnings as well.  A return to a price to sales ratio of 2.5x, and a return to peak revenue, would imply a stock price of $38 from the current $11.38, not including more share buybacks, or future acquisitions.  I believe Heartland Express has the capacity to be a medium term three bagger or better with a return to historical multiples and an increase in revenue due to the end of destocking.  In the longer term, if Mike Gerdin finds more acquisition targets, the inorganic growth from the rollup could continue.   With the recent improvement last quarter in gross profit, there are good odds that the worst of the headwinds are over.