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Morningstar | Unusually Tight Truckload Capacity a Strong Tailwind in C.H. Robinson's 2Q; Results In Line

Wide-moat third-party logistics specialist C.H. Robinson’s second-quarter gross revenue increased a healthy 15% to $4.3 billion, once again ahead of our expected run rate thanks to stronger-than-anticipated sell rates to shippers (truckload and less than truckload), which made up for a slight shortfall in core truckload shipment volume. Unusually tight truckload market capacity is behind the firm's strengthening pricing power. Global air and ocean forwarding revenue also exceeded our forecast. Gross profit margins on truckload business didn’t strengthen as much as we anticipated, but that’s probably due to the impact of higher fuel surcharge pass-through revenue. The firm is executing nicely in a rapidly changing rate environment, as truckload sell rates came in ahead of the rise in capacity costs; thus, gross margin trends aren’t much of a concern. Operating margins were mostly in line, save for near-term weakness in the produce sourcing division (Robinson Fresh). Core North American surface transportation profitability is healthy, and global forwarding operating margins recovered sequentially on better cost execution.

Overall, we didn’t materially alter our midcycle revenue or margin assumptions, but we expect to increase our $81 fair value estimate to $83 on the time value of money since our previous update. At about $94, the shares are trading at a 13% premium to our new fair value estimate, placing the stock in slightly overvalued territory--a common theme among the top-tier highway brokers we cover (including Landstar, Echo, and XPO), as the highly favorable operating backdrop is already baked into investor expectations, in our view.

Second-quarter net revenue (gross revenue less transportation costs) in the core North American surface transportation division, which includes the flagship highway brokerage unit, increased a solid 21.5% year over year, driven by strong sell rates to shippers rooted in unusually tight trucking market capacity. NAST net revenue growth was largely in line with the gross revenue increase (up 21%) as gross profit margins held up, rising 10 basis points to 15.2%. Margins would’ve been higher if not for the negative mathematical impact of rising fuel surcharges. The favorable pricing environment, including success repricing contractual business, is bolstering C.H. Robinson’s ability to pass along higher rates paid for truck capacity. Buy rates spiked 19.5%, but sell rates to customers increased slightly more, up 20.5%; that gap was negative in the first quarter. We expect this positive trend to persist for the remainder of 2018 and into the first half of 2019. Truckload industry capacity is likely to remain abnormally tight in the second half on the back of strong freight demand (macroeconomic trends), the driver shortage, and widespread electronic logging device adoption among truckers, and this bodes well for moatworthy, asset-light highway brokers.

Less-than-truckload shipment volume expanded a solid 6%, but core truckload volume contracted 4.5% as lost freight awards linked to contract repricing efforts in recent quarters more than offset double-digit growth in transactional volume. That said, truckload volume trends improved sequentially (following the 7.5% first-quarter decline) and year-over-year comparisons remain tough; volume rose 8% in the same period last year as the firm strategically took market share. Since the company has repriced most of its committed accounts (about 75%), we expect shipment volume to see continued improvement in the back half of the year. C.H. Robinson has a long history of successfully balancing market share gains and pricing in highly competitive markets (and throughout the freight cycle).

C.H. Robinson’s consolidated operating margin (calculated off net revenue) swung positive on a year-over-year basis in the second quarter, rising 90 basis points to 32.6%. NAST operating margin increased 330 basis points to 42.3%, despite rising variable incentive compensation, thanks to leverage from net revenue growth and productivity gains (segment head count was steady). Global air and ocean forwarding margins declined 220 basis points to 20.7% on increased head count, higher variable compensation, and incremental amortization related to the third-quarter 2017 Milgram acquisition. That said, segment margins improved drastically from the 6.7% posted last quarter, with help from solid volume gains and improved overall execution, including tighter expense control. Robinson Fresh division (produce sourcing and transportation) margins deteriorated as well, in part because of incentive compensation increases, higher claims expense, and lost leverage from lower case volume linked to lost business from a customer that exited the fresh produce business.

For the remainder of 2018, we expect healthy pricing conditions in terms of sell rates on truck brokerage business to provide incremental leverage over the expense base in NAST, and we look for tight expense control to persist at Robinson Fresh. Longer term, we also have high confidence in continued operating margin gains in the global forwarding operations as the firm realizes synergies from recent acquisitions and capitalizes on heavy IT-related investments aimed at process automation. Overall, C.H. Robinson continues to comfortably rank among the most profitable providers in the third-party logistics industry.