Risks of Investing in ABFS

The last post showcased the opportunity that exists with Arkansas Best (ABFS:NYSE). As with any investment, there are risks. Given the nature of their business (shipping via trucks), several risks come to mind:

• Capital investment: ABFS has $461M in fixed assets (net of depreciation), which works out to about $18.40/share--this is clearly not a "light" business; additionally, investment may be required track assets/deliveries (IT infrastructure) and to support the trucks (maintenance and repair)
• Repeat business: There's a lot of competition in trucking; while customers repeatedly use the trucking, they may choose from a bevy of other carriers
• Differentiation: Since trucking services are ostensibly commoditized, ABFS has to differentiate itself (products, service, price) in the marketplace to establish their brand
• Margins: Their net profit margin (3.18% is below the industry average of 6.58%)

There are plenty of other risks as well (many of these are generic in nature): rising labor costs, increasing regulatory burden, management skill and modal conversion (i.e., shippers switching to other methods of shipment such as rail).

With that being said, it appears that ABFS is quite effective in dealing with many of these risks. Even though one of its subsidiaries is in a union stronghold (Clipper Exxpress is in Woodbridge, Il), Arkansas Best seems to have done a good job of avoiding labor strife. To keep costs low and service level high, Arkansas Best has set up two subsidiaries, Data-Tronics and Fleet Net. these two subsidiaries provide 2 essential services to Arkansas Best: shipment tracking and truck breakdown/repairs. Facing the option of doing this in-house vs. outsourcing, they appear to have launched these 2 services as standalone businesses (similar to how Ford spun off Visteon). Hopefully they will meet with more success than Ford!

Differentiation appears to be along the lines of operational excellence and scale. For the most part, ABFS appears to promote from within (they recently appointed a new president of Data-Tronics, a 28 year company veteran). Nevertheless, there is a major red flag with respect to margins, which are significantly below the rest of the industry. This bears more research, as it points to differentiation on price (which requires persistent, focused efforts to maintain low costs).

Lastly, ABFS has mitigated the modal conversion risk with their Clipper Exxpress subsidiary which operates in the intermodal space (intermodal shipments are the trailers you see riding on flat railroad cars).

Overall, they appear to have a good command of their business (they've won their share of trucking awards) and a decent amount of industry credibility. The only real red flag appears to focus on their low margins, which will be explored in more detail. Nevertheless, at current valuations, there appears to be a decent bit of Margin of Safety with Arkansas Best.