Follow the Yellow Truck Road

At least that's what shares of freight haulers USF (USFC) and Yellow Roadway (YELL) did Wednesday following a report the pair is involved in merger talks. Citing unnamed sources, The Wall Street Journal put the value of the possible linkup at more than $1 billion. USF's stock revved 13.1% higher to $37.73; Yellow climbed 4.7% to $57.95.

Based in Chicago, USF is best known for its less-than-truckload business, which involves carrying loads of less than 10,000 pounds, but most recently attracted more notice for its management turnover and labor disputes, which cut 25 cents out of its fourth-quarter earnings per share. USF posted a quarterly profit of 23 cents after deducting executive severance and the cost of shutting down its Red Star unit in May. Wall Street estimates called for earnings of 59 cents a share, which were still down 13% from the fourth quarter of 2003. USF's woes caused shares to drop from a Dec. 28 peak of $38.39 to a recent low of $32.21 on Feb. 1.

Jason Seidl, a trucking analyst with Avondale Partners, an independent investment bank in Nashville, says changes in USF's top management haven't helped it in the last few years. Chief Executive Richard DiStasio was forced from the cab last year after disagreements with the board, forcing Thomas Bergmann, chief financial officer, to take the wheel. That, says Seidl, left the company a bit underpowered.

"I would say clearly they're not at an optimum level," he says. "The CFO has no transportation background, and though I think he's a good CFO for the firm, he clearly doesn't have significant trucking experience."

Yellow Roadway, on the other hand, has had the hammer down since it was created through the combination of Yellow and Roadway in a December 2003 deal valued at $966 million. Since Dec. 11, the day the merger took place, the stock of the Overland Park, Kan., company has jumped 58%, including Wednesday's run-up on the speculation of yet another big deal.

Within the trucking sector, which is divided into truckload (TL) and less-than-truckload (LTL) businesses, the consolidation makes plenty of sense. Less-than-truckload is the fastest-growing market segment, although LTL stocks have traded down an average of 2.2% relative to the S&P 500 over the last three week, according to Bear Stearns analyst Edward Wolfe.

These companies are hauling more goods, and that's having an effect on their business, he writes in a quarterly sector review published Wednesday. In the quarter ended Dec. 31, Yellow's average weight per shipment increased 1.7% from the same period a year before, and USF's average shipment weight went up by 5.1% from the previous year.

Wolfe, who has a Peer Perform rating on the stocks of both Yellow and USF, says a more likely outcome is the sale of USF's logistics business, which is valued at about $288 million. "Although YELL is interested in building out its regional and next day LTL business, we believe that it is still in the exploratory phase and is not yet ready to commit to a large scale entrance to that market," he writes in a separate note, also published Wednesday. (Wolfe doesn't own shares of USF or Yellow Roadway; Bear Stearns makes a market in both stocks.)

USF didn't return phone calls; Yellow Roadway issued a statement saying it doesn't comment on market rumors and speculation.

The way less-than-truckload shippers do business has allowed them to pass on most of the rising fuel costs directly to customers, says Avondale's Seidl, which has kept them somewhat more insulated than their truckload competitors. That and the barriers to entry in the LTL space make the coupling of USF and Yellow intriguing.

"Since 1999, less-than-truckload has seen significant consolidation within the industry, and no one's really started up a new LTL company," he says. "To do that, you need bricks-and-mortar and significant technology behind you. To become a small LTL carrier, you need terminal space, dock workers and a management system. It's a lot harder to do than truckload."

Consolidation has allowed the remaining trucking firms to push through price increases, which helped USF to 9% annual revenue growth from 2004, with total sales of $2.56 billion, which translates into earnings per share of $2.48, or 29% year-on-year growth. After the Roadway merger, Yellow earned $3.75 a share in 2004 on sales of $6.8 billion.

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"At this point, it's just unsubstantiated rumors," says Seidl of Avondale Partners. "But you can't completely dismiss them, because they make sense. It would really bolster Yellow Roadway's presence in the regional LTL marketplace, which is the fastest-growing segment." (Seidl doesn't own shares of USF or Yellow Roadway; Avondale Partners makes a market in both stocks.)