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Get 30% Upside With This Side Play On The Economic Recovery

Marshall Hargrave

As consumers, we love our new cars, the hottest electronics and great food. However, we rarely think about how those items get to our local stores.

Broadly speaking, all those things are brought to us by the shipping industry. Grocers, electronics stores and energy companies all rely on major trucking and shipping companies. And a rebounding economy is great for shippers and transporters. After all, the more goods people buy, the more goods are shipped.

However, what many investors don't realize is that the best way to play the shipping market might not be your typical trucking or rail company, but the company that helps those providers operate more efficiently. That's where Echo Global Logistics (Nasdaq: ECHO) comes in.

Echo caters to the shipping industry, providing transportation and supply management solutions. Its business model is centered on serving clients in the transactional spot market, as well as providing full service third-party logistics (3PL) outsourcing and analytics. Echo offers a developed platform that's easily deployed, making the company highly scalable.

Echo's key customers are small and midsize shippers, but the entire 3PL outsourcing industry is growing quite nicely: nearly three times as fast as the transportation industry as whole, according to Echo.

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The beauty of Echo is that it's diversified across the entire shipping sector, making it one of the best broad plays on shipping and logistics. It caters to nearly 29,000 customers, and no customer accounts for more than 10% of revenue. What's more, Echo serves truckload and less-than-truckload carriers, as well as intermodal, parcel delivery and domestic air service providers, all on either a per-shipment or contractual basis.

In its third quarter, Echo posted earnings per share (EPS) of $0.19, slightly below expectations -- but it also saw another record growth in revenue and income, up 22% and 15%, respectively, from the same quarter the previous year.

Echo has set an ambitious 2016 target sales goal of $1.4 billion to $1.6 billion, which is more than double its 2012 revenue. This is expected to result in annual EPS more than doubling to $1.50 to $2 a share. Analysts expect EPS to grow at an annualized rate of near 30% over the next five years. Coupling that growth with Echo's current valuation gives a price/earnings-to-growth (PEG) ratio of a low 1.0.

Reaching those robust revenue and earnings targets will require greater penetration and margin expansion. Although margin pressure has been a concern, the company is making impressive headway on the productivity front. Margins on 2012's earnings before interest and taxes (EBIT) came in at 16.5%, and Echo hopes to have that figure up to 25% to 30% by 2016.

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Further driving growth in its top line and margins is Echo's plan to make key acquisitions that have operating margins of 20% or more. The most exciting news is that Echo currently has no debt and cash on hand equal to nearly 10% of its market cap -- meaning it has the balance-sheet strength to drive growth through internal investments and strategic acquisitions.

Risks to Consider: The key risk for Echo is that the economic recovery loses steam or stalls entirely, given that shippers, Echo's key customers, rely heavily on the broader economy. A delay in margin expansion would likely dampen its EPS growth. Moreover, transactional services can be competitive, and Echo has no moat protecting this part of its business, unlike its contractual services.

Action to Take --> Buy ECHO for long-term upside to $45. Even if EPS comes in at the low end of estimates at $1.50 in 2016, the upside is still vast, even with no multiple expansion. A price-to-earnings (P/E) multiple of 30, which is below Echo's five-year average and the current industry average, on that 2016 EPS projection suggests ECHO could hit $45 in 2016, or a roughly 30% annual return from current levels.

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