Can TFI Avoid Picking Up Where UPS Left Off?

Can TFI International Inc. succeed when UPS Inc. could not? Beginning July 1 or thereabouts, the rubber will hit the road.

UPS' UPS decision to sell its troubled less-than-truckload (LTL) carrier, UPS Freight, to Montreal-based TFI International TFII puts the LTL industry, for the most part, in Big Brown's rearview mirror. UPS will no longer spend millions of dollars a year to prop up a noncore business whose margins and operating ratio — the ratio of expenses to revenues — have become embarrassments to a company renowned for its operating efficiency. It will end dealings with 11,500 Teamster workers, an aggressive group who forced UPS to shut down the unit's operations in 2018 over a contract dispute, and whose costs made UPS Freight uncompetitive in a largely nonunion industry. The $800 million in TFI cash for the unit will provide UPS with significant capital to be used to pay down debt or re-invest into faster-growing segments of delivery.

In selling, UPS will cut its losses from buying Overnite Transportation Co., the forerunner to UPS Freight, for $1.25 billion in 2005.

For TFI, as savvy an operator as there is in trucking, the deal presents opportunities and risks. In terms of geographic reach, the TFI unit, TForce Freight, becomes arguably North America's premier LTL carrier. It adds a sizable U.S. network and Mexican connections to its intra-Canadian and northern border operations. TFI acquires 197 well-maintained North American terminals and 6,340 tractors and trailers. It also gains a little-noticed but well-run dedicated truckload business, which accounts for about 9% of UPS Freight's $3.1 billion in annual revenue. The truckload unit will be embedded with the old Contract Freighters operation that was acquired in 2016 from XPO Logistics Inc. XPO and that is now headed by Greg Orr, a highly regarded truckload executive. 

When the deal closes by the end of the second quarter, the TFI unit will be a $4 billion enterprise with the former UPS Freight merged with TFI's existing business. Neither UPS nor TFI would comment for this story. UPS releases its full-year and fourth-quarter 2020 results next Tuesday, and it's almost certain the sale will be a topic of conversation on the subsequent analyst call.

TFI has a long-held reputation for maximizing value from its costing and pricing initiatives. It will clearly make some changes at UPS Freight. A small part of a massive parcel-delivery business, UPS Freight was positioned from the start as a loss leader. UPS bundled the unit's services with its higher-margin small-package portfolio, and priced the LTL business below the market with the idea that shippers would send it more parcel business along with the cut-rate LTL traffic. 

It is unclear whether the strategy was effective in pulling in more parcel business. However, the low rates, combined with labor costs that are 10% to 11% above the industry average and an inability to command premium rates charged by elite rivals Old Dominion Freight Line Inc., ODFL, Saia Inc. SAIA and XPO were too heavy a rock for UPS Freight to continue pushing uphill. Based on data that UPS disclosed on Monday, UPS Freight currently has an operating ratio (OR) of 98%, meaning it spends 98 cents for every dollar in revenue. By contrast, Old Dominion, the gold standard for LTL, reported a stunning 74.5% OR in its third quarter. TFI has vowed to drive down TForce Freight's OR to 90% within three years.

TFI will also have to contend with a collective bargaining agreement that expires in 2023, and the possible static from a formidable group of Teamsters. TFI, which has said it will honor all existing contracts, has a unionized unit in its portfolio. However, dealing with trucking Teamsters, especially a group that fought a bitter but futile war to organize Overnite from 1999 to 2002, may be different than working with Canadian labor. "It's like letting a bear in the room," said an LTL industry executive. TFI's ability to sustain solid margins may depend on what savings and efficiencies it gleans from the next contract.

TFI does not have skin in the parcel game — though it operates a decent-sized last-mile delivery business — and has no motivation to maintain bundles and tolerate cut-rate LTL yields as does UPS. TFI will either raise rates on existing customers or cut them loose entirely, said Jason Seidl, analyst for Cowen & Co. Even with higher rates, TFI may retain more business than expected because former UPS Freight shippers will be hard-pressed to find attractive alternatives in a sector where pricing is firm and carriers have stayed disciplined, Seidl said in a note on Monday.

The UPS Freight acquisition is an "exceptionally rare opportunity (for TFI) to grab nationwide scale in a market that has good secular tailwinds from e-commerce and rail-like pricing," Seidl said. TFI is Cowen's top trucking pick, and Seidl significantly raised his 2021 and 2022 estimates in the wake of the acquisition and bullish macro trends. He also raised TFI's 12-month target to $82 a share from $53.

Lance Healy, co-founder of Banyan Technology, an IT provider to the LTL sector, said the TFI unit will be free to "review and realign pricing agreements, especially those that may have been influenced to attract a higher parcel spend." This "liberation from outside influences" augurs positively for TFI as long as it pursues opportunities with a steady hand, Healy said.

For its part, TFI is bullish on the prospects of managing such a vast LTL network. In a 15-page presentation posted on its website, TFI said the transaction is expected to be accretive to diluted earnings-per-share results in 2021, and will be "substantially accretive over time." The company has made 90 acquisitions in the past 12 years, and its shares have risen, on a cumulative basis, 9,604% in the past 20 years. That blows away comparable returns from its peer group, the S&P 500, and the Toronto Stock Exchange's TSX.

Although UPS is shedding LTL ownership, it is far from exiting the segment. Under the terms of a "transition services agreement," UPS will, for at least the next five years, resell a UPS Freight offering for TFI known as Ground Freight Pricing, where a grouping of parcels weighing more than 150 pounds and not requiring palletization moves through UPS' parcel processing network but is priced as cheaper LTL consignments. The program, considered the only one of its kind in LTL, generates about 12% of UPS Freight's $3.1 billion in annual revenue. The reselling agreement puts UPS in the unusual role of acting like a general sales agent on behalf of another company.

UPS' involvement with TFI won't stop there. For the next three years, it will provide unspecified back-office support to the new operation. UPS will also retain all assets and liabilities relating to pension, retirement and other benefits for the unit's 14,500 former employees until the deal closes.  

For now, left unanswered is what benefits UPS will receive from TFI for reselling and for back-office services, and why it remains involved with the TFI operation at all. One theory is that UPS does not want to dismantle the bundled relationships where it has access to the small-package traffic that is its bread and butter.