Running on Empty with Werner Enterprises

Werner Enterprises (WERN-$18.37), one of the nation's largest truckload carriers, is being hammered by rising fuel prices and a slowing economy. And, with oil trading near $140 a barrel, earnings are decelerating.

The trucking company principally serves the consumer and non-durable goods segments (such as retail and groceries). Freight demand softness in the housing and automotive sectors, however, is increasing fleet capacity as truckers shift hauling schedules, targeting Werner’s freight markets.

The trucking operator has historically been successful in mitigating its exposure risk to fuel price increases by collecting additional surcharges from its customers. These revenues increased 58.6% to $95.7 million in the first-quarter ended March 31, due to higher collections.

Rising Diesel Costs Affect Margins

In the past, Werner negotiated higher rates with customers to recover the fuel expense shortfall in base rates per mile. Surcharge recompense is becoming more difficult in the current operating environment, for either the customers are unwilling to cough up the differential and/or day-to-day pricing volatility of diesel is making it more difficult to shorten the timing lag of the billing-payment cycle.

Due to an ongoing driver shortage, wages remain the most significant operating cost, eating 27.9 cents of each dollar in sales (down 1.9 cents per dollar of sales from March 2006), but fuel-costs soared to 24.1% of net sales, up from 17.6% last year, attributed to higher average diesel fuel prices.

The 10Q Detective notes a remarkable unwillingness by management to travel the risk management road. The company has no plans to contract derivative financial instruments intended to reduce its exposure to fuel price fluctuations and offset surcharge recovery issues.

Ongoing initiatives, such as reducing truck idle time and lowering non-billable miles, will not compensate for rocketing fuel costs, which increased 16.6 cents per total mile for the 1Q:08. This trend is expected to continue in coming quarter. In the month of April 2008, diesel fuel prices increases an averaged $1.22 per gallon compared to April 2007, to more than $4.00 a gallon.

For the week ended June 23, on-highway diesel prices averaged $4.65 per gallon, up $1.81 from one-year ago, according to the Energy Information Administration.

Rail Transport Competition

Even though on-time delivery service percentages are generally higher for truckload shipments than rail intermodal means of transport, the higher price of diesel fuel impacts truckload carrier costs and rates more significantly than it does intermodal providers. As a result, Werner believes that some price-sensitive shippers have been shifting a greater portion of their long-haul freight from truckload to truck-rail conveyance in recent months—-exacerbating already weak freight demand in its longer haul routes.

In fiscal 2007, responding to this mode shift, management cut fixed costs by eliminating more than 750 vehicles in its Van fleet, its long hauler subsidiary.

Corporate Governance

Net income in fiscal 2007 fell 23.6% to $75.35 million, as higher fuel costs and weaker freight demand depressed rates. Nonetheless, the Board awarded Chairman Clarence L Werner, (son) Vice-chairman Gary L Werner, and (son) Chief Executive Gregory L Werner, the same cash bonuses received in fiscal 2007: $350,000, $230,000, and $350,000, respectively.

• The company employs Scott Robertson, Clarence’s son-in-law, as its "Director-Aviation," which means he pilots the company jet. In 2007, Werner paid to him $167,734 (which included company car expenses, too).
• Daniel Matthew, son Gary’s brother-in-law, is gainfully employed with the company’s Fleet Division, earning $142,700 in 2007.
• During 2007, the Company paid $7.5 million to Pegasus Enterprises, owned by Clarence’s brother, Vern Werner, and sister-in-law. During that time, the Company paid $424,614 to WinRow Farms, which is owned by Vern Werner, too. Pegasus Enterprises and WinRow Farms lease tractors and drivers to the company as owner-operators.
• Although the company leases a hunting & fishing lodge, which includes a sporting clay range, from Clarence Werner for only one-dollar per annum, it has made approximately $6.1 million in "lease-hold improvements" in the past decade.

Would it be expecting too much of the company to hire a non-Werner with knowledge of oil hedges, swaps and collars?

We can do anything that we want
We can, We can, We can
We can do anything that we want ~ British singer Piper Billie, "Because We Want To" lyrics (Summer 1998)

The Werner family beneficially owns 41.9% of the stock outstanding.

Investment Outlook

The company’s balance sheet is strong, with no long-term debt, contractual obligations to property and equipment of about $63.6 million, and a book value of $8.25 a share.

The stock price has rebounded some 20 percent from January lows (intra-day bottom of $15.26 a share on January 9), as investors positively respond to Werner’s operational metrics—which continue to outperform other truckload long-haulers.

In our opinion, the bulls are breathing in too much diesel fumes, for the 4.3% year-over-year gain in average revenues per truck per week and the 0.9% decline in average empty load tonnage for the first-quarter ended March 31, better reflect a reduction of 720 trucks on the road—not improvements in utilization and pricing.

Although we are neutral on the company, those with one eye on the horizon may want to get back on the road again with Werner. The company is one of the few truckers paying a dividend, with a nominal 1.10% yield ($0.20 per share).

In addition, as freight rate costs become prohibitive to smaller trucking operators (including independent contractors), we look for more going 'out-of-business' signs, which should position Werner for greater truckload volumes and modest pricing power improvements.

However, given worsening truckload tonnage, spiraling diesel prices, and tough weather, such as Midwest flooding—-the visibility of improving freight demand near-term remains cloudy.

An earnings miss in coming quarters increases the likelihood, too, that the stock price of Werner will revisit its January lows (intra-day low of $15.26 a share on January 9).

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.