Coronavirus Pandemic Creates Some Uncertainty for Ryder's Dividend
As we discussed in our November 2019 note, Ryder (R) wasn't firing on all cylinders prior to the coronavirus pandemic.
The company's largest segment, Fleet Management Solutions (61% of revenue), provides vehicles, maintenance, and related services to businesses that need a fleet of trucks to move products to their customers.
About two thirds of the segment's revenue is from contractual lease agreements with an average term of around 6 years.
Source: Ryder Investor Presentation
Ryder purchases trucks at a discount due to its volume, provides guaranteed maintenance to improve customers' uptime and lower their costs, and then sells the vehicles after their leases expire through used truck retail centers.
Historically, about 20% of Ryder's annual cash flow was generated from selling used trucks.
Unfortunately, last year used truck prices fell at the fastest pace management has seen in at least 25 years, leading Ryder to expect used vehicles to be priced "at historically low levels" in 2020 and 2021.
Assuming Ryder's core leasing business continued generating stable results, we didn't expect weak used vehicle prices to threaten Ryder's dividend, which has been paid without interruption since 1976.
Several months after our note, COVID-19 took the world by storm. We were willing to take a wait-and-see approach with Ryder since the virus outbreak had potential to benefit parts of its business.
For example, demand for logistics and distribution services (26% of revenue) seemed likely to rise in certain industries as more consumers shopped online and retailers that stayed open dealt with a surge of demand. Ryder also generates more free cash flow during downturns since it doesn't need to buy as many trucks.
On April 2, Ryder provided a mixed business update.
Management said the firm has seen deterioration in its Supply Chain Solutions segment (26% of revenue) due to production shut downs in the auto industry, which represented 11% of firm-wide sales in 2019.
Ryder's automotive customers generally expect to resume production in 4-6 weeks from now, but conditions remain very fluid.
The story is similar in Ryder's Dedicated Transportation Solutions segment (13% of sales), in which Ryder supplies the truck and a driver to make deliveries on behalf of customers. Some industries are experiencing lower volumes and others like consumer packaged goods are seeing significant volume increases.
The good news is that lower volumes and revenues in non-automotive industries in these segments have a lesser impact on Ryder's earnings since its fees are less transaction based.
The bigger issue is that demand for Ryder's light and medium duty commercial rental trucks has "decreased significantly" and is expected to remain weak at least through the second quarter.
Management also anticipates demand for Ryder's used vehicles to be hurt as a result of the general economic slowdown, resulting in lower sales results at least through the second quarter.
In an effort to improve free cash flow, the company is canceling or postponing new vehicle orders and working to redeploy idle equipment among its customer base. Actions are also being taken to reduce discretionary spending.
Management didn't comment on the dividend but said the company's "liquidity position remains solid."
As of April 6, Ryder had $409 million available under its $1.4 billion credit facility, which expires in September 2023. Ryder also maintains an available cash balance of $1.2 billion, which can cover its $600 million of debt that matures this year.
For context, Ryder's dividend costs about $120 million annually and could presumably remain covered for a period of time even if the business somehow failed to generate free cash flow, which seems unlikely.
Even during the financial crisis in 2009 Ryder generated over $300 million in free cash flow thanks in part to its ability to cut new vehicle purchases in half.
The company's free cash flow figure that year also doesn't include the $211 million of used vehicle sales proceeds Ryder received, which provided additional cushion.
In February 2020, CEO Rob Sanchez suggested that the dividend would remain safe since Ryder was looking past transitory challenges and saw no change in its long-term earning power:
Dividends have historically been for us really an indication of long-term earnings potential. So if you look at our long-term earnings potential, we don't see a change in that at this point. So our view around it, it's a long-term indication of where we're going. And we don't see that as having changed significantly here with [weaker used vehicle prices]...
The dividend policy overall is really tied to our long-term earnings expectation. Right now, based on the earnings we're producing, obviously, the yield is pretty significant. But we see that changing over the next several years as [the used vehicle prices] impact starts to subside and we get back to more normalized earnings level. So our view is to really keep it consistent with where we think we're going, which would kind of keep us in the range that we're in right now.
The coronavirus pandemic presents a level of uncertainty that management has never seen before as major parts of the economy remain frozen.
Lease and rental activity could remain weak for the foreseeable future, used vehicle prices could slump further, and some customers may struggle to honor their lease agreements given the demand shocks they are facing.
It's hard to say how long management will tolerate these headwinds, which will keep Ryder's debt-to-equity ratio above its 2.5x to 3.0x target for at least this year while a potential recession looms.
The company could afford to continue paying its dividend, but there's a chance it may choose not to given today's unusual circumstances.
Overall, we think a dividend cut would be surprising at this stage given the company's liquidity, countercyclical free cash flow profile, and historical commitment to its dividend.
However, due to the unprecedented uncertainty facing the company, which could lead management to be extra conservative with debt reduction and capital preservation, we are downgrading Ryder's Dividend Safety Score from our lowest Safe score to Borderline Safe.
Ryder's score could be upgraded quickly if the U.S. economy is able to reopen soon and management reiterates its supportive stance on the dividend.
Regardless of what happens in the short term, this isn't necessarily a reason to sell.
The company's long-term outlook arguably hasn't changed, Ryder's transportation and logistics services remain essential to the U.S. economy (once it has fully reopened), and the firm's investment-grade balance sheet can help it weather the storm.
A lot of bad news is already in Ryder's stock price as well. Investors just have to be comfortable with the company's unusually low level of visibility for now.
