Masterful supply chain management can have a positive impact on the value of a company's stock. No one recognizes that more than longtime investment analyst John G. Larkin, who has made a career out of following the transportation and logistics space.
Recognized as an all-star analyst by Institutional Investor magazine and The Wall Street Journal, Larkin has been tracking transportation stocks for two decades. He's currently managing director and head of transportation capital market research at Stifel, Nicolaus & Company Inc.
Larkin began his career in the transportation industry in 1977, at the Center for Transportation at the University of Texas at Austin. After graduating from Harvard University with a Master of Business Administration degree in 1984, Larkin joined the rail carrier CSX Transportation. From there he went to the investment bank Alex. Brown & Sons, and from 1998 to 2001 was chairman and chief executive officer of RailWorks Corp., a railway construction and maintenance company. He then returned to the investment field, joining the asset management firm Legg Mason to lead its entry into the transportation market. Legg Mason's capital markets group was sold to Stifel, Nicolaus & Company in 2005.
In a recent interview with Editor James Cooke, Larkin discussed how supply chain executives can increase shareholder value.
Name: John G. Larkin
Title: Managing director and head of transportation capital markets research
Organization: Stifel, Nicolaus & Company Inc.
Education: Bachelor of Science in Civil Engineering, University of Vermont; Master of Science in Civil Engineering, University of Texas?Austin; Master of Business Administration, Harvard University
Work History: Research assistant at the Center for Transportation at the University of Texas at Austin; Transportation systems consultant at Day & Zimmermann Inc.; various positions in planning, and economic analyst at CSX Transportation Inc.; Managing director at Alex. Brown & Sons; Chairman and chief executive officer of RailWorks Corp.; Managing director at Legg Mason
CSCMP Member: Since 2012
As someone who follows transportation and supply chains from an investor's perspective, can you describe a couple of ways a company can use its supply chain to boost its shareholder value?}
First, shippers can create shareholder value by harnessing their supply chains to reduce the cost of goods sold. A lower cost of goods sold will expand margins and increase earnings, EBITDA (earnings before interest, taxes, depreciation, and amortization), or free cash flow—all three of which happen to be the basis for most equity-oriented valuation models.
[There are many ways to reduce the cost of goods sold.] By optimizing product packaging—thereby wasting less space on a transportation vehicle—and optimizing product design—making it less bulky and more concentrated—shippers can fit more product on a single vehicle. These changes can reduce the number of vehicles used and, in turn, the cost of transportation.
Next, shippers can optimize their modal mix by making sure that they are using the right blend of parcel, less-than-truckload, truckload, intermodal, rail carload, barge, or pipeline services. Then they can optimize the number and location of distribution centers with the idea of optimizing modal mix and fully utilizing lowest-cost capacity. And of course, shippers can rationalize and optimize their supplier base with an eye toward minimizing transportation costs, improving the quality of finished goods, and fully leveraging purchasing economies.
Secondly, shippers can create shareholder value by improving their capital-employed ratio. They can do this by minimizing the amount of inventory transiting the supply chain while simultaneously reducing the risk of stockouts. They can also minimize their transportation/logistics department overhead—outsourcing to a 3PL (third-party logistics service provider) or a 4PL (fourth-party logistics service provider) may help here. Another option is leasing facilities where there is a dearth of demand or a surplus of facilities exists, and they can lease any rolling stock. Less capital employed typically translates into less money borrowed and less interest paid. Less interest expense, in turn, enhances margins and free cash flows, either of which are often used by investors to value companies.
When you look at a carrier's balance sheet, what catches your attention first, and why?
It is usually the degree of financial leverage found on a company's balance sheet that I first examine. Highly leveraged companies pay more to access capital than do more conservatively capitalized companies. They often make short-term decisions in order to avoid default, which may suboptimize both service to shippers and the creation of shareholder value. Conversely, companies with little debt—or with few operating leases for that matter—have the flexibility to grow at a moment's notice and can walk away from bad business and/or unattractive pricing.
During the economic downturn many companies have looked to their supply chains to free up "working capital." Do Wall Street investors look favorably on those initiatives, and why?
I believe that Wall Street looks favorably on these sorts of initiatives, as additional capital is now—in theory—available, assuming the initiatives accomplish their objectives: to invest in core assets and profitable growth. Those to whom a company normally outsources typically have lower costs of capital, better systems, more relevant knowledge, and much better buying clout. These 3PLs and 4PLs are willing to share the savings with the shipper, thereby lowering operating cost, and at the same time can often relieve the shipper of its need to own trucks, trailers, material handling equipment, warehouses, and so forth. The freed-up capital can then be redeployed into the shipper's core business.
At the CSCMP Annual Global Conference in Atlanta, you made a couple of intriguing statements. The first was that companies should be prepared for "less Asia, more Mexico" and more "insourcing." Can you explain what you mean by that?
For the past three decades or so, manufacturers have raced to shift manufacturing to China. That was essentially a "no brainer" decision for many years. However, with fuel prices rising, raw materials sometimes difficult to source in Asia, and Asian labor costs rising, some are finding Mexico to be a lower-cost alternative for sourcing manufactured goods that are both labor- and transportation-intensive. Recent studies by AlixPartners and the Boston Consulting Group have confirmed this "nearshoring" thesis. Of course, manufacturing that is not transportation-intensive, such as electronics, will likely remain in Asia for the foreseeable future.
You also said at the conference that new advances in robotics could prove to be game changers in the supply chain. How so?
Products that can be manufactured in a heavily automated or "roboticized" facility may come all the way home to the good old USA. As you might expect, the robot costs the same in Kansas as it does in Vietnam.
There's been a big push to make supply chains "green." Are investors supportive of those efforts?
Most investors like a clean environment as well as the next guy. However, they are often less fanatical about it than are the hard-core environmentalists. What they are most interested in is value creation. If the green strategy doesn't reduce costs, enhance free cash flow, reduce asset intensity, make a product more strongly desired by customers, reduce inventories, and so on, then investors generally are less interested in whether a strategy is green or not. The exceptions to this rule are the managers who are running funds that have a strict mandate in their charters to invest in an environmentally responsible fashion. A good number of these types of funds exist.
Finally, pull out your crystal ball. Where is the U.S. economy headed in 2013?
The economy has been growing at less than half the rate one would expect to see coming out of such a deep macroeconomic trough. The lack of economic leadership in Washington has contributed to this tepid growth, in my view. But so has the uncertainty in Europe, the Middle East, and China. At home, though, we have been dealing with all sorts of headwinds, such as rising energy prices, the housing crisis, a plethora of new federal regulations, and the lack of fiscal policy discipline.
So, my guess is that with the current administration remaining in power, we will be looking at continued tepid growth, say 1- to 2-percent GDP (gross domestic product) growth per annum. Those that pay the bulk of the taxes simply don't like hearing that they aren't doing their fair share and will take fewer risks with their capital.