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Frozen Food Express - Third Time's a Charm

9/5/2012

On August 15, 2012, we alerted GeoInvesting premium members that we initiated a small position in FFEX around $1.70. On August 28, 2012 when the stock cracked $2.00 to the upside we then stated that after further due diligence we increased our position in the stock.

It's no secret that our team goes the extra mile to search for hidden clues in press releases, conference calls, investor presentations and SEC filings. In essence, we attempt to buy stocks before the masses piece the bullish or bearish clues together to notify our followers of potentially profitable investment opportunities.

  • This due diligence process led us to accurately predict that information buried in a December 16, 2009 8K filing would lead to former GeoBargain Merrimac Industries being acquired at a significant premium to its then current share price of around $10.00. Just one week later Merrimac agreed to be acquired by Crane Company for $16.00 per share which represented a 60% premium from the price of our alert.
  • On May 12, 2009 we published a note discussing why we believed clues presented during an earnings conference call would lead investors to buy Cpi Aerostructures (NYSE Amex:CVU) shares that had receded by $1.95 to a price of $6.15 after investors were too quick to judge weak numbers in a quarterly financial press release. The stock quickly recovered and reached $8.17 within days and eventually went on to reach much higher new highs.
  • On November 11, 2011 we wrote about Orchids Paper (NYSE Amex:TIS) and a special dividend clue mentioned in a November 9, 2011 press release that the market had not fully priced in its shares. The stock gained 50% over the next 3 months, reaching a high of $19.25 on February 9, 2012.

Our most recent bullish micro-cap article we published on seeking alpha was on GeoBargain Goldfield (NYSE AMEX:GV). Since then GV shares have risen 40 % partly fueled by hidden clues of insider buying, which by the way has continued even at elevated prices.

As one of our favorite authors Peter Lynch notes in "One Up On Wall Street", tracking stocks in sexy industries with slick names can prove a useful investment tool.

This brings us to Frozen Food Express Industries, Inc. (Nasdaq: FFEX), another stock that we predict will rise sharply in the near-term. FFEX is the leading temperature-controlled truckload and less-than-truckload carrier in the United States with core operations in the transport of temperature-controlled products and perishable goods including food, health care and confectionery products. A series of both technical and fundamental clues suggest that FFEX is about to embark on a good ride. Like GV, we believe that FFEX could be another superior stock under $5.00 that could see its shares move significantly higher over the next several weeks.

Technical clues:

Although we are not avid technical traders, we sometimes reference the charts to determine if they are forecasting that improved fundamentals are around the corner.

Our technical clue can be simply illustrated by observing FFEX's 23 year chart history, dating back to 1989.  

FFEX Price Chart

When viewing the price of FFEX over the last twenty plus years, it becomes clearly evident that there appear to be recurring patterns that indicate that FFEX shares may be in the beginning stages of a sharp bull move.

Since 1989, FFEX has entered two enormous bullish cycles that began from a price point under $3.00. The first cycle began at the tail end of 1990 when the stock was trading around $2.00 , setting the stage for a multi-year run that sent shares to $14.60 by November of 1993. Early during the next decade shares experienced an even quicker bullish period, rising from $2.40 in April 2003 to $12.90 in November 2004.

Four interesting corollaries are worth noting during these two periods of exponential share price increases:

  • The presence of an upward breakout from a period of a flat-line chart pattern.
  • The bullish move was quick and furious, rewarding those who recognized the story told by the chart.
  • Investors who did not participate early in the bullish cycles experienced far less, or even negative, returns.
  • The recovery from the troughs is getting shorter; the first run took nearly 3 years to the peak, while the second run reached its peak in half the amount of time.

Fast forward to the current bullish period, and it appears that FFEX is on the brink of a third disruptive buoyant move. Since mid-July 2012 shares have quietly risen from levels similar to those that existed at the onset of previous positive price cycles. It is clear that the market is starting to piece together the bullish clues of this story.

Soon enough, momentum indicators may break this story to the masses. While we generally perform research on stocks that attain new 52 week highs, we often also screen for companies that attain 6 month highs, which helped lead us to FFEX. This task can place attractive investment opportunities on our plate before the momentum mover (momo) crowds congregate to shares, such as Investor Business Daily readers that generally reference 52 week highs to identify momentum plays. We are eager to see what happens when the momo crowd jumps in, once FFEX's prices breaches the 52 week high at $3.15.

Notice that we haven't even discussed the fundamentals of the FFEX story. But as you will read, the technicals are really manifestations of the fundamentals fueling the chart.

The Fundamental Clues: Investors who value FFEX on trailing EPS numbers will be late to this party

Notifying our members of potentially profitable investments before everyone else joins the party frequently forces us to tinker outside of 'the box'. Healthy companies with steady earnings tend to show up on screens and are often appropriately priced in the market, having for the most part been already found by the "crowd."

So on occasion a company catches our eye that has far from impressed for a while, but is beginning to show signs of life. This in and of itself is far from compelling, but when profitability has been recently restored and the fat has been trimmed from an operation that has a prior history of solid, prolonged periods of quality earnings...we dig a little deeper.

FFEX was able to post a surprisingly profitable 2012 second quarter.

  • Income from operations was $1.6 million compared to a loss of $3.8 million in the same period of 2011.
  • Net income was $1.1 million compared to a loss of $3.3 million in the same period of 2011.
  • EPS was $0.06 compared to a loss of $0.19 in the same period of 2011.

Why is this significant? Prior to the 2012 second quarter FFEX had posted a loss in 13 straight quarters

 

2012

2011

2010

2009

March, Q1

Rev (millions)

EPS

 

87.9

(0.32)

 

92.1

(0.45)

 

85.8

(0.22)

 

92.2

(0.36)

June, Q2

Rev (millions)

EPS

 

95.7

0.06

 

101.3

(0.19)

 

94.9

(0.26)

 

94.8

(0.30)

September, Q3

Rev (millions)

EPS

 

TBA

TBA

 

102.8

(0.77)

 

93.8

(0.13)

 

94.5

(0.15)

December, Q4

Rev (millions)

EPS

 

TBA

TBA

 

92.1

(0.67)

 

94.1

(0.09)

 

91.4

(0.15)

Totals, Full Year

Rev (millions)

EPS

 

TBA

TBA

 

388.4

(2.08)

 

368.8

(0.69)

 

373.0

(0.96)

FFEX has been implementing a strategic plan to restore profitability by exiting low margin/low return businesses, reinvesting in growth businesses, improving operating efficiencies and improving yields in its core temperature controlled business. Specifically, the company has exited Dry Van Services and updated its fleet to decrease fuel and maintenance costs while an on-going driver shortage has shrunk capacity, creating a favorable pricing environment. These initiatives should equate to greater operating leverage, meaning that small gains in revenues can result in more proportionate gains in earnings. We are very excited about a new source of potential growth revenue resulting from the Company's entrance into bulk tank water transportation/logistics services for the crude oil drilling industry that began during the fourth quarter of 2011. No customer represents over 9% of the company's sales and the top 20 customers represent only 55% of total sales.

Will these efforts bear fruit past the 2012 second quarter or was it just a flash in pan? Our interpretation of the fundamental clues leads us to convincingly conclude that FFEX is about to embark on consistent profitability for several quarters into the future, something the chart is already telegraphing. With each successive quarter more investors will begin to find FFEX.

The clues:

  • Commentary from the second quarter 2012 press release regarding going forward profit and EPS implications was not clearly obvious unless you put pen to paper. The comments from the second quarter release by CEO Russell Stubbs...
    "Given the higher fixed cost nature of the LTL business, incremental contribution from even modest improvements in revenue can have a significant impact on our profitability and returns, which is evident in our improving results. Combined with a growing contribution from our water transportation business, we are on track to restore the Company to profitability this year."
    ...leads us to conclude that the company will come close to reporting $0.26 in the second half of 2012, considering that through the six months ended June 30, 2012 the company lost $0.26.

  • In its August 2012 investor presentation the company provides 2012 second half EBITDA guidance of $5 to $7 million per quarter. After doing the math and using the midpoint of this guidance, we calculate that FFEX will report EPS of around $0.13 in each of its 2012 third and fourth quarters. Not only does this data reinforce our EPS assumption derived from information contained in the 2012 second quarter release, it also shows us that FFEX should be solidly profitable in both of its remaining 2012 quarters, a fact we could not totally conclude from the press release. Astute investors who dug past the release have gained an advantage which we believe is being reflected in the stock price as information becomes more "known." Furthermore, investors who have attended/are attending conferences where the company is presenting its story are also getting a first-hand glimpse of the company's EBITDA guidance. On August 28, 2012 the company attended the Midwest IDEAS Investor Conference and will be presenting at the Dahlman Rose and Company - Global Transportation Conference on September 5, 2012 in New York. 

  • During the 2012 second quarter conference call, Chief Operating Officer John Hickerson commented that
    "FFEX is in the "early innings" of a nice turnaround story."

This is precisely what the chart is telling us!

Valuation

For the time being, we will assume that FFEX can maintain an EPS $0.13 run rate on a go forward basis for five out of the next six quarters and come close to breaking even in its 2013 first quarter which is the company's seasonally weakest quarter (FFEX reported a large loss in its 2012 first quarter). This should lead to the company attaining four straight quarters of superior EPS growth which should provide sufficient fuel to the shares.

Applying a P/E of 15 to our 2013 EPS estimate of $0.39 ($0.25 fully taxed) would translate into a near-term share price of $5.85 ($3.74 fully taxed). Investors who argue that our P/E assumption is too aggressive for a mature company need to realize that FFEX has often traded at a premium P/E in the past. FFEX also deserves a premium P/E since it is not just a leader in its industry category; it is the leader. Investors who also argue that out 2013 first quarter EPS assumption is too aggressive must realize that we have countered this by being overly conservative in assuming that FFEX's 2013 second, third and fourth quarter financials will not improve from the current run rate.

EBITDA is a nice tool to use to value companies that experience disproportionate losses in certain quarters and how we feel the market may have valued FFEX shares in the past. Thus, to appease the more conservative investor we will also apply a valuation target assuming that:

  • The 2013 first quarter EBITDA will not improve from the 2012 first quarter EBITDA loss of $3 million.
  • EBITDA for the seasonally stronger quarters (Q2, Q3, and Q4) of 2013 will not improve from the current company estimated mid-point run rate of $5 million.

Based on these assumptions we calculate that FFEX will report 2013 EBITDA of $12 million or $0.66 per share.

This yields a near term (current) price target of $3.3 to $4.62 based on 5 to 7 times our 2013 EBITDA per share forecast of $0.66.

Any way you slice it, FFEX shares are undervalued, even when using conservative assumptions.

Significant upside to the story and price target:

  • The historical chart shows that shares trade ahead of the fundamentals.
  • FFEX's entry into the oil exploration industry provides a tremendous opportunity for a new source of growth to augment a business that has matured.
  • If the company is able to return to profitability in its historically weak first quarter (as has been the case at times in the past), our 2013 EPS, EBITDA and near term price target assumptions will prove to be way too conservative.
  • Our valuation assumptions are overly conservative since we have not baked in an increase in current EPS and EBITDA run rates for 2013.
  • A recovering economy could accelerate growth. FFEX provides services for major retail and wholesale providers in a number of industries.
  • An increase in qualified drivers to meet increased demand.

Conclusion:

Investors who value FFEX on trailing numbers without looking at the clues will end up buying FFEX shares when the story becomes obvious. Don't be late to this party. Let the third time be your charm.

Caveats:

  • Fuel Prices: Although the company is able to pass on part higher fuel costs as surcharges to some of its customers, a sudden rise in fuel prices (from economic shocks like Middle Eastern conflicts) could lead to a delay in price adjustments.
  • Weak Revenue growth: FFEX operates in a mature industry that has led to the company reporting little to no revenue growth over the past five years. One factor that can possibly jump start revenue growth is FFEX's penetration into new rapidly growing markets, such as the bulk tank water transportation/logistics services for the crude oil drilling industry water.
  • Driver shortage: Due to stiffer industry wide regulation the amount of quality drivers available in the market has been reduced. Although this has an inherent advantage of helping the industry maintain favorable pricing, it does reduce the amount of drivers available to meet increased demand. To counter this issue FFEX has started its own driving school academy which has helped it find and keep quality drivers on board at more economical prices than normal recruitment strategies.
  • Seasonality: The Company has a history of reporting losses in its fiscal first quarter. However, the company has at times been able to report a profit in the first quarter. The last time this occurred was in 2006. Although we believe investors are aware of the seasonality, reporting a substantially reduced loss (a scenario we believe will happen) in its first quarter of 2013 may be a key catalyst to convince investors that this turnaround story is firmly in place.
  • Even though the company provides third and fourth quarter 2012 EBITDA guidance in its August 2012 investor presentations we will take the quarterly inference in a cautiously optimistic manner. We will give more focus to the $10 to $14 million cumulative EBITDA numbers inferred by the quarterly guidance. Regardless, the company‚Äôs comments in the second quarter press release and its August and September 2012-investor presentation supports a $10 to $14 million EBITDA outcome.

Disclosure: Long FFEX, CVU, TIS, GV

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