Just Inside the Zone
- Eric Cinnamond
- Mar 27
- 7 min read
<March 27, 2025>
It’s that time of the year again: high school softball season! I always look forward to watching my daughter’s team play, especially their at-bats. There’s nothing like the sound of a hard-hit softball!
As I watched my daughter’s first at bat of the season, I was hoping for a big hit. I’d take a single, but, in my mind, I could picture her leading off with a double, or even a home run!
The first pitch was thrown! It came in a little outside—ball. The next pitch was high—ball. And so on and so on. Before I knew it, she had four walks and didn’t swing once! The next game was similar. Even when an occasional strike crossed the plate, she just wasn’t swinging. Something was off.
The following weekend we went to the field for batting practice. I pitched her several buckets of balls and afterward said, “Well, there certainly isn’t anything wrong with your swing. Looks great.” My daughter responded, “I never said there was anything wrong with my swing.” I said, “Of course, I just assumed since you weren’t swinging something was off.” “Dad, I didn’t like the pitches. There’s nothing wrong. It’s only been two games, and the pitches will improve. You need to be patient.”
In moments like this, I often question who is doing the parenting. I’d be embarrassed to disclose how many times my daughter has taught me valuable life lessons. And of course she was right. In subsequent games the pitching improved, and that loud crack of the bat returned. I added this experience to the long list of reasons why I’ve never made it on the cover of Parenting Magazine!
With stock prices soaring over the past two years, the equity market hasn’t been throwing a lot of great pitches. Equity valuations have reached heights not seen since past bubble peaks. High-quality stocks have been particularly expensive, and in our opinion, carry an unacceptable amount of valuation risk. This is especially true based on our view that profit margins have been inflated by unsustainable fiscal deficits, debt growth, and asset inflation.
Historically, all market cycles have ended, with bull markets being followed by bear markets. It’s the way it’s always been and, in our view, the way it will always be. While extraordinary and intrusive monetary policy has tested this long-held truth, given current valuation and credit excesses, we believe the current market cycle will face the same fate as past cycles.
While we’re uncertain if recent volatility in the equity market is the start of a real downturn or just another wiggle before the next move higher, we’re encouraged and are finding more small cap stocks to consider for purchase. While higher-quality small cap stocks remain very expensive, the valuations of companies possessing operating or financial risk are becoming more attractive.
As recession fears grow, stocks of cyclical businesses have been under increasing pressure. Instead of debating if we’re in a recession, we’re searching for value in depressed cyclical stocks that we believe are already pricing in a recession. Heartland Express (symbol: HTLD) is a good example.
Founded in 1978 by Russell Gerdin, Heartland Express is a short-to-medium haul trucking company. The Gerdin family continues to own 41% of Heartland’s common stock. Michael Gerdin is currently Chairman and CEO. Since going public in 1986, Heartland has grown revenues from $22 million to $1.05 billion in 2024. Heartland has historically generated above average profit margins by remaining efficient, safe, and debt free. Heartland differentiates itself by keeping its truck fleet new, safety record clean, and deliveries on time. The company considers itself a provider of premium transportation services and prices its services accordingly.
While Heartland has a long history of above average margins and growth, its stock and business stumbled in 2023-2024. Much of the company’s struggles resulted from a slowdown in the trucking industry.
During COVID, the trucking industry prospered as the government flooded the economy with stimulus and companies struggled to maintain sufficient inventory. The supply chain was strained, increasing the demand and price for transportation services. As companies rushed to restock empty shelves and warehouses, they eventually went too far and replaced an inventory shortage with an inventory glut. In response, businesses began reducing inventory, decreasing the need for transportation and putting pressure on trucking rates. The consumer’s shift from buying goods to services added to this pressure. In effect, the trucking industry has gone through an intense boom and bust over the past five years. Heartland enjoyed the upside and is now experiencing the downside.
In a recent interview, Heartland’s CFO stated he believes the current trucking industry downturn is worse than 2008-2009! The industry’s recession is now in its third year, which has exceeded the length of traditional transportation downturns. As the inventory destocking cycle nears its completion and trucking capacity slowly leaves the industry, we expect operating trends will improve in 2025, albeit gradually.
In addition to industry weakness, we believe a portion of the decline in Heartland’s operating results was self-inflicted. Specifically, Heartland has had trouble integrating two of its most recent acquisitions. The timing of both purchases, in our opinion, was not ideal.
Near the peak of the trucking boom in 2022, Heartland bought two competitors. The first was Smith Transport, headquartered in Pennsylvania. At the time of purchase, Smith had a fleet of 850 company trucks, with an average age of less than three years. Heartland paid $169 million, or 5x Smith’s EBITDA. The second and much larger acquisition was Contract Freighter’s Inc. (CFI). Heartland paid $525 million for CFI and its 2,100 trucks and 8,000 trailers. CFI had sales of $575 million and came with seven terminals in desirable locations. After completing both acquisitions, Heartland became the 8th largest trucking company in the United States.
We owned Heartland’s stock in 2022 and sold it shortly after both acquisitions were announced. In addition to Heartland’s stock trading near our valuation, the debt required to complete the Smith and CFI acquisitions exceeded our financial risk tolerance. Since we sold our position, Heartland’s stock has declined meaningfully. Meanwhile, its balance sheet has improved considerably as management has made it a priority to reduce debt. In effect, Heartland’s valuation and balance sheet have become much more attractive since 2022.
While the process of integrating its acquisitions and bringing margins closer to the company’s historical average is ongoing, we believe operational improvements and efficiencies will become more noticeable as industry conditions improve. Further, we’re hopeful management has learned a valuable lesson related to acquiring cyclical businesses with debt during industry booms. It’s a great lesson for investors too!
In our opinion, the best time to buy a cyclical stock is when the company’s profits are in decline and its industry is in recession. In effect, buy during the bust, not the boom. Of course, this is much easier said than done. Investing in a company when its fundamentals and stock price are declining is difficult! One of the things that has made it easier for us to invest in Heartland is their ability to generate free cash flow, even during the current industry decline.
While we expect Q1 2025 will be another weak quarter for Heartland, we believe results will slowly improve throughout the year. We also expect the company will continue to generate free cash flow and reduce debt, decreasing financial risk and increasing shareholder value. In summary, we believe Heartland will survive the current trucking recession, continue to improve its balance sheet, and benefit from the industry’s eventual recovery.
With small cap stock prices declining, Mr. Market is throwing us better pitches. While they’re not the fat high-quality pitches we’d prefer, they’re just inside the zone nonetheless! Based on current valuations, we expect to maintain our focus on stocks that have already priced in a recession and a less favorable credit environment. We also intend to save some swings (capital), for the eventual high-quality pitches we expect to see once the current cycle ends. Be patient, Mr. Market’s arm is showing signs of fatigue!
Eric Cinnamond
The Palm Valley Capital Fund can be purchased directly from U.S. Bank or through these fund platforms.
Index performance is not indicative of a fund’s performance. It is not possible to invest directly in an index. Past performance does not guarantee future results. Current performance of the Fund can be obtained by calling 904-747-2345.
There is no guarantee that a particular investment strategy will be successful. Opinions expressed are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Fund holdings and allocations are subject to change and are not recommendations to buy or sell any security. Current and future portfolio holdings are subject to risk. Click here for the fund’s Top 10 holdings.
Mutual fund investing involves risk. Principal loss is possible. The Palm Valley Capital Fund invests in smaller sized companies, which involve additional risks such as limited liquidity and greater volatility than large capitalization companies. The ability of the Fund to meet its investment objective may be limited to the extent it holds assets in cash (or cash equivalents) or is otherwise uninvested.
Before investing in the Palm Valley Capital Fund, you should carefully consider the Fund’s investment objectives, risks, charges, and expenses. The Prospectus contains this and other important information and it may be obtained by calling 904 -747-2345. Please read the Prospectus carefully before investing.
The Palm Valley Capital Fund is distributed by Quasar Distributors, LLC.
Definitions:
Dry van rate: Trucking rate data gathered from Truckstop.com and presented by Bloomberg. Average trucking equipment rate and the inbound and outbound lane rates are measured in dollars per mile.
Operating risk: The risk associated with the uncertainty and volatility of a company’s cash flow resulting from the cyclical nature of their industry and economy.
Financial risk: The risk associated with the financial leverage or debt on a company’s balance sheet. Typically, the more debt relative to cash flow and assets the more financial risk.
Free Cash Flow: Cash from operating activities minus capital expenditures and adding proceeds from equipment and property sales.
Enterprise Value/Sales: The enterprise value-to-sales (EV/Sales) ratio is a financial metric that compares a company's total value (enterprise value) to its annual sales. It helps investors assess a company's valuation relative to its revenue, with lower ratios indicating potential undervaluation and higher ratios suggesting overvaluation.
Net debt: A company’s total debt minus its cash and equivalents.
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of a company's operating performance that focuses on its profitability by excluding non-operating expenses and non-cash charges, providing a alternative view of pre-tax cash flow generation.