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Morningstar | C.H. Robinson’s 1Q Gross Revenue Drops as the TL Capacity Crunch Eases but Margins Impressive

Wide-moat logistics specialist C.H. Robinson’s first-quarter consolidated gross revenue declined roughly 4.5%, slightly below our expected run rate as pricing to shippers on truckload business in the North American Surface Transportation (NAST) segment pulled back more than we were expecting. Some of that is simply noise from very difficult comparisons (the truckload capacity crunch drove robust rate gains in early 2018), but it sounds like freight demand has moderated more than we were originally thinking. That factor may be creeping into C.H. Robinson’s contractual rate negotiations with shippers this bidding season. Contract rate gains were previously strong over the past year, and we expected those gains to provide more support through the first half. Industry freight demand and pricing aren’t falling off a cliff, but truck brokers are emerging from an unusually robust backdrop and there’s bound to be variability as conditions normalize. On the other hand, NAST gross profit margins expanded more than we expected due to capacity rates falling faster than pricing to shippers, and that increase allowed NAST net revenue to rise 11%. C.H. Robinson’s overall operating profitability came in better than we anticipated thanks in part to strong execution, including good headcount management.

Since our midcycle revenue and profitability assumptions remain mostly intact, we don’t expect to materially alter our $83 DCF derived fair value estimate. Trading at about $81, the shares are appropriately valued relative to our longer-term expectations for top-line, profitability, and free cash flow growth. That said, this is a much more palatable market valuation compared with much of 2018 when investor expectations for third-party logistics companies were a bit lofty.

Valuations across the logistics space eased by the end of last year, partly because investors recognized that the highly favorable operating backdrop for highway brokers (strong contract pricing and robust spot opportunities) would normalize in 2019, translating into much more moderate net revenue and EPS growth. This dynamic has long been baked into our fair value estimate for C.H. Robinson.

Of note, the stock saw some selling pressure over the past few days in response to recent news headlines that Amazon Freight may be looking to push further into the truck brokerage industry. Information is limited, and the firm’s strategy is unclear, but it does add some risk that Amazon Freight could drag down brokers’ pricing to shippers on certain lanes in the year ahead if it’s willing to forego a spread over cost of hire (gross margin) in the interest of gaining share. In our view, Amazon is more of a threat to the large incumbents than other upstart digital freight brokers like Uber Freight and Convoy because of its ready-made network of shippers and carriers, and because Amazon has often been willing to ignore near-term profits when it enters a new market. On the other hand, we continue to believe the domestic U.S. highway brokerage market remains fragmented enough to absorb another large player without sending industry gross margins into a long-term chronic downward spiral. Further, C.H. Robinson has a long history of successfully navigating the ubiquitous threat of new entrants. Nonetheless, this will be a factor to watch.

In terms of key highlights, first-quarter net revenue (gross revenue less transportation costs) in the core NAST division, which includes the flagship truck brokerage unit, increased 11% year over year; it grew more than 17% for full-year 2018. NAST’s net revenue increased despite the 4% fall in segment gross revenue because gross profit margin expanded 230 basis points to 17.4%. This is a common trend when truckload-market pricing softens because C.H. Robinson can pass along lower carrier rates on a lag to committed shippers--sell-rates charged to customers fell 5.5% in the quarter, while buy-rates for truckload capacity fell 8.5%. The decline in sell rates stems in part from very difficult comparisons--truckload-market capacity was unusually tight in early 2018, driving C.H. Robinson’s rate per mile (ex fuel) charged to customers up a robust 21%. We note global forwarding segment net revenue increased roughly 3.5% on the back of gross margin expansion, as air and ocean volume trends were muted due in part to U.S. shippers pulling forward imports into the 2018 summer months ahead of potential tariffs in 2019.

C.H. Robinson’s consolidated operating margin (calculated off net revenue) increased a healthy 250 basis points to 33.1%. NAST operating margin increased to 43.4%, from 41%, thanks to leverage from net revenue growth as well as productivity gains (solid headcount management) rooted in heavy IT investment in recent years. Global air and ocean forwarding margins improved nicely in the quarter, with help from net revenue growth and employee productivity gains.