Transportation & Logistics Investment Banking: The Industrials Group, Part 2
When you hear “industrials,” your first thought might be manufacturing and mechanical equipment.
And then there’s aerospace & defense, which is really just another type of… very large mechanical equipment.
But after you get done manufacturing all this heavy-duty equipment, you still need to transport it to its final destination – and this is where transportation & logistics coverage comes into play.
The full name of the industrials group is “Diversified Industrial Goods & Services.”
The “services” delivered here aren’t so much consulting, HR, or changing font sizes in PowerPoint presentations, but rather moving goods from one point to another.
Here’s your map for today’s interview:
- How to punch your ticket and set your destination for transportation & logistics investment banking
- Walk through the lay of the land when it comes to covering transportation companies
- Circumnavigate the technical aspects of both financial analysis and industry analysis (NB: the sector is “industrials” and the industry is “transportation”)
- Discuss the more popular deal types, and where to go after you’ve clocked out of transportation coverage
Q: So how’d you arrive in the transportation sector?
A: Similar to your other stories on group placement, my story is based on mutual fit. There are perennially popular groups such as consumer / retail and M&A; they attract the most banking analysts without a doubt.
One of my associates once told me, “Your job is to do the task that nobody else wants to do.”
That’s a bit true in this role: the group placement process isn’t perfect, and the end result comes from a mix of fate, luck, and your own quality rapport with your desired group.
In this case, I was drawn to the group because they were hiring and it seemed like an “under-valued and overlooked asset” to me – I’d prefer being in a lesser-known but more promising group vs. a “cool group” that’s about to be downsized.
Any group is better than no group, and just as there are things to complain about – there are things to appreciate as well. :-)
Q: What do people in your group like to read when it comes to following the sector?
I know you’ve mentioned it in other articles, but Dealogic’s industry deal alerts are pretty helpful. If a corporate combination (read: merger or acquisition) or capital raise occurs, you’ll see it through the email alert.
It also gives you a sense of which industry groups are most active – obviously by of how many emails you receive!
Of course, that assumes you are signed up with multiple email addresses… but I didn’t give you that idea.
Laying the Track and Charting the Course: The Ground Transportation Landscape
Q: So what’s the industry like? Give us the overview.
A: Here’s how I’d think about it: capital goods encompass companies that manufacture parts and equipment such as for aerospace and defense; so aircraft manufacturers and parts fall under capital goods.
Transportation includes those companies that employ those parts as part of services you pay for.
Under that definition, airlines themselves would fall under transportation.
Something like an auto parts company could be a cross between industrials and consumer, so either the industrials group or the consumer group might cover it, depending on the bank.
Logistics companies focus more on the management of distribution networks and the elements that surround any box in transit: tracking the box, choosing the right carrier, figuring out how to best load a freight car, etc.
A good number of logistics companies really carry out the logistics function as part of their broader product offerings.
See page 51 of “The Logistics Journey” for a more in-depth definition of what constitutes a logistics company.
Now to a few specific sub-industries within ground transportation:
Rail: These operators are divided into various classes depending on their revenue.
According to the American Short Line and Regional Association, a “regional operator” is one with ”at least 350 miles of road and/or earning revenue between $40 million and the Class I revenue threshold ($398.7 million).”
Genesee & Wyoming notes that “local operators” report between $20.0 and $31.9 million in revenue and run with less than 350 miles of track.
The definition gets even more detailed when you include interline (switches tracks along the way), local (begins and ends on the same track), and overhead traffic (passes through multiple tracks that aren’t the start or the finish of the journey).
As you probably know, there are two kinds of railroads out there: passenger and freight.
The largest passenger operator in the United States is Amtrak (National Railroad Passenger Corporation), which is actually partially supported by the US government (their annual expenses exceed their revenue by over $1 billion sometimes).
With freight transport, on the other hand, you focus much more on cost effectiveness and you see less instances of government sponsored support in the form of tax breaks or subsidies.
Road (Trucking): Imagine the various ways you can load a vehicle, and you understand this sector in a nutshell.
This area encompasses dedicated trucking, general trucking, and cross-border trucking.
Dedicated trucking can focus on longer-term contracts, with lower driver turnover and higher margins. According to one trucking company, this dedicated service has can be tailor-made and can augment existing trucking capacity.
So if you needed an extra set of trucks to deliver toys around the holidays, you could call up this type of firm.
General trucking refers to the traditional flat-bed, or even refrigerated freight loads, that proceed through one-way movements.
How can a truck beat out a railroad when it comes to transporting goods?
For one, a train can’t go everywhere. So a trucking company can focus itself on regions where there aren’t many tracks, and keep the travel distance as short as possible.
Delivering the Technical Cargo
Q: Would you have any interesting pitch books or fairness opinions to show our readers?
A: Yes I do, take a look at these:
- Rail: Berkshire Hathaway / BNSF by Greenhill
- Rail: Genesee & Wyoming / Rail America by Deutsche Bank
- Truck: Swift Corporation by Goldman Sachs
- Truck: Transport Corporation of America by Stephens
Since transportation falls within industrials, you see the same comparable company valuation multiples: Enterprise Value / EBITDA, Enterprise Value / EBIT, and P/E.
You may also notice the use of an operating ratio (operating expense / sales) in some of those exhibits.
Aside from comparable company valuation metrics, you should expect to see the usual discounted cash flow analysis based on Unlevered Free Cash Flow, historical equity prices, equity research analyst price targets, premiums paid analysis, and precedent transactions list. Precedent transactions almost always focus on LTM EV / EBITDA multiples.
Sometimes, you also see variations of premiums paid in this sector, such as the premium paid compared to the share price 30 days before announcement, the 30-day volume weighted average price, the IPO price, the twelve-month high, the twelve-month low, and so on.
Q: Awesome. What about the key operating ratios when analyzing a transportation company?
A: When it comes to particular line items, I once heard a story about how railroad cars have to be depreciated individually. Then I worked on a railroad deal and didn’t actually see that, so it might be something that an accounting firm’s transaction services department handles.
In this sector, we pay attention to how well a company uses its assets and how that’s reflected in its return on invested capital (definitions vary, but one way to define it is Net Operating Profit After Taxes / Invested Capital. Invested Capital is generally close to Total Debt + Preferred Stock + Equity).
To learn more about this metric and related metrics, please see our tutorial on ROIC vs ROE and ROE vs ROA.
For trucking companies, the more industry-oriented metrics focus on a company’s number of owner-operators and even the number of company drivers.
Owner-operators are akin to employees who own equity in a company, and that creates big differences in motivation.
At the same time, an owner-operator is responsible for his/her own set of operating expenses, so some expense pressure is taken off and passed onto employees.
These drivers tend to produce higher weekly revenue than company drivers and are compensated on a rate per mile basis. You can find a road transportation glossary here.
Stephens has also assembled a good set of operating metrics for comparable companies:
- Average Length of Haul (in miles or kilometers)
- Dead-head % / Fleet: This metric refers to the number of tractors pulling empty trailers.
- No. Trailers / No. Tractors: Naturally, what this industry is working with is a set of trucks that pull freight boxes on wheels. Those short trucks that have just a driver’s cab are called tractors.
- Insurance & Claims / Revenue
- Average Age of Fleet: Older machinery typically requires more maintenance, and that will affect the bottom line (since Depreciation always impacts the Income Statement).
- Average Age of Trailers
- Tractors / Maintenance Personnel
- No. Driver / No. Non-Driver Employees
- Average Annual Revenue / No. Non Driver Employees
Q: So what moves the market for transportation?
A: External to the company, you’re looking at the demand for imports and the extent to which a nation facilitates commerce via roadways.
Compared to manufacturing companies, there are lower barriers to entry because start-up costs consist of simply a fleet and drivers.
Operating costs are high, however: the wear and tear of the individual vehicles, insurance, fuel, and toll fees add up.
According to Swift Transportation, a trucking company’s customer base might include: retail, discount retail, consumer products, food and beverage, manufacturing, and transportation and logistics firms.
If you noticed, there are a bunch of consumer / retail companies in this list of road transportation companies.
Naturally, their inventory levels and ability to fund working capital needs will influence whether these clients can hire transportation firms.
Similar to the aviation industry, there is a balance between filling every freight car and not letting any freight car run empty.
There is a bit of price competition among transportation firms, especially if a company chooses to pursue multiple bids on the same mandate. Amassing too many tractors and trailers (idle ones) is a very bad thing.
With rail transportation, the story is much more focused on basic materials – you’ve got metals in the mix too.
Naturally, you should be thinking about the health of metals & mining companies and how it impacts the railroad sector health.
The story extends to other commodities such as grains, paper & pulp, oil, gas, and even chemicals.
Seasonality is a big factor, as you would expect. The late third quarter and fourth quarter are the busiest times of the year, with the first quarter of the calendar year usually reporting less demand for transportation services.
The second and third quarters (in North America) provide optimal conditions for capital expenditures.
Government incentives also influence the health of railroad operations. As you might imagine, there are both tax breaks and capital injections that support construction. These two items corroborate the railroad sector as one of those “strategic resources” so important to most countries.
Employees themselves are also vital to the railroad industry.
Unions add another element to the dynamic of finding the right talent to the right position.
Into the Sunset
Q: Who are the major firms and boutiques that compete in the transportation sector?
There was a time when The Transportation Group, formed from some guys from Paine Webber, would be on that short list as well.
Be careful not to mix up “transportation boutiques” with leveraged aircraft leasing firms – sometimes there is a bit of overlap, but in most cases they are distinct and banks are on the sell-side, while leasing firms are on the buy-side.
Several of the bulge bracket banks, including Deutsche Bank, maintain transportation coverage that is distinguished from the rest of the industrials department.
You might see professional resources pooled in such an arrangement at the VP level, or even at the analyst level – an analyst might spend his/her time divided between aerospace/defense and transportation. A friend of mine had exactly that experience at RBC Capital Markets.
For the top bulge bracket banks, the list doesn’t change too much from the list for the broader industrial coverage bankers. Expect to see JPMorgan and Citi’s banking teams as leaders on advisory assignments.
Q: What are the more common tasks and deal types in a transportation group?
A: The transportation sector is highly regulated, so you don’t see airline or railroad mergers & acquisitions happening too often.
In some sectors, such as rail, there are very few acquisition targets, limiting M&A activity. Most of the acquisition ideas concern regional players or “short-line” operators.
So you see a lot more capital raising in the industrial sector, specifically on the debt side – these companies usually have solid collateral and stable cash flows, making them ideal candidates for debt.
Genesee & Wyoming specifically cites strategic investments and operations as pillars of its approach to business.
As a result of this relative lack of M&A activity, partnerships, joint ventures, and other “non-M&A deals” can be more common in the sector as well.
Q: Where do transportation professionals move to after punching out?
A: Most go into industrial-related investment funds or head to business school.
Just because you worked in transportation doesn’t mean your experience can’t apply into a more capital goods oriented role.
Q: Any final words of advice?
A: Keep on truckin’!
Seriously, times can get tough and your co-workers can be rough, but you really need to take initiative where you can, and realize that for every whiny professional, there are ten incredibly enthusiastic newbies itching and hungry to take your seat at the table… so don’t take your foot off the pedal.
Q: Great, thanks for your time!
A: My pleasure.
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