Forward Air: A Show-Me Story That Could Unveil Upside Potential (NASDAQ:FWRD)

In January of this year, we covered the complex deal that was ongoing between Forward Air (NASDAQ:FWRD) and Omni. At the time, Forward tried to walk away from the transaction, prompting a lawsuit for breach of contract filed by Omni to force the closure. Eventually, the parties reached a settlement with some revisions of certain terms, and the merger was consummated. Since then, the stock has been down 55% with the market clearly not appreciating the deal, as we anticipated. However, we think the company is now in a show-me story where things could eventually change for the better, and provide an entry point.

The company shakeup: leadership changes and a brief financial update

As a brief reminder, the merger was mostly a stock transaction where Omni shareholders received close to 40% of FWRD share capital as a mix of common and preferred shares that need to be converted.

Additionally, Omni shareholders were also in line for a $150 million cash payment. However, as a result of the settlement agreement reached in January, the terms have been changed a bit, with Omni shareholders now received only $20 million in cash and 35% of the combined entity shares, on a fully diluted basis. But all this is quite old history, and many things happened in the meantime. First, the company stopped issuing guidance in the latest earnings call in late February. Management stated they would “evaluate when the timing is right to provide it on a go-forward basis”. This was clearly not helpful for investors and is likely one of the reasons behind the continued decline and pressure on the stock price.

Among all these changes, governance at the combined entity was also impacted by a shakeup. CEO Tom Schmitt departed the company soon after the deal closed. Recently, the company announced Shawn Stewart as a replacement. All in all, these are the factors behind the poor stock performance over the past months.

Overpessimism might have driven the valuation to bargain levels

We believe that since our first analysis, the stock is now reflecting a very different scenario. The pro forma valuation of the combined entity could now be low enough to justify close monitoring of the upcoming results to evaluate a possible long entry. We reached these conclusions by looking at the forward multiples attached to the company, and those of the sector as a whole. In our last analysis, we reported our bear case based on the fact that the stock was trading at a pro forma forward EBITDA multiple of 6.0x, which compared to a sector’s average of 4.8x looked expensive. Today things changed dramatically. With the equity valuation now slashed, the forward multiple is close to 3.4x 2024E EBITDA.

This is the non-adjusted multiple declining after the deal closed on February 29, 2024. After using the company-disclosed $610 million figured as the post-synergies EBITDA for 2024, we feel confident that the valuation framework is very different today than it was in January.

Even if we exclude the $75 million of expected synergies, we end up with a multiple of 3.9x, which is again consistently below the sector’s average. Now, it is time for the company to prove this through the next quarter’s earnings, and by re-instating guidance as soon as possible. Overall, there is a significant re-rate opportunity if the multiples expand from the current levels to the average of 4.8x. To be conservative, we also apply more layers of security by (1) adjusting forward EBITDA by excluding synergies, and (2) assuming a multiple below the market average at around 4.2x. The fair value in this scenario would be around $28 per share, computed assuming (1) $1.5 billion of debt, which includes $1.7 billion of debt less pro forma cash, and the current market cap of $575 million. This is more or less aligned with our previous analysis, where we indicated a fair price of around $30. Improvements to or above that level may still be possible, but management will need to post improvements on the results and a better communication strategy.

Risks: uncertainty prevails in the trucking market and at FWRD

We have not been fans of Forward Air. We believe the deal with Omni destroyed much value for shareholders (an indisputable claim confirmed by the share price). For this reason, we feel that investors need to carefully approach this position and consider these risks: (1) execution/management risk, and (2) industry risk. The company itself needs to prove to the market that they are capable of executing on the prospected synergies. There is some risk around this, and the next earnings releases will be crucial to understand the progress on this front. Last but not least, the company operates in a market that is subject to price volatility (freight rates). This can severely impact the company’s margins and ability to generate FCF.

Conclusion

Forward Air suffered from a depressed stock performance over the past few months. The valuation multiples, once expensive, retraced to much lower levels, making the stock cheaper than we expected. In this scenario, we think a re-rate is possible under the condition that the company proves to the market that it is able to fully integrate Omni, and deliver on earnings expectations. The target per share is initially set at $28.