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Morningstar | Echo’s 3Q Organic Top Line Growth Quite Strong; But Brokerage Market Conditions Likely Nearing Peak

Narrow-moat highway broker Echo Global Logistics’ third-quarter gross revenue expanded 27% year over year on continued growth in managed-transportation business and solid increases in sell-rates to shippers (spot and contract) linked to unusually tight truckload-market capacity over the past year. The July FMP tuck-in acquisition (LTL managed transportation) also contributed slightly. Revenue was mostly in line with our forecast, though operating profitability is trending modestly ahead of our expected run rate, benefiting from the favorable truckload-market backdrop and internal efficiency gains.

Since our midcycle model assumptions remain largely intact, we do not expect to materially alter our $25 fair value estimate. Echo’s market valuation has come down to more reasonable levels in recent months following roughly a year hovering in what we considered to be overvalued territory. In our view, Echo’s stock price (along with several peers) was previously baking in overly optimistic midcycle growth assumptions, but we think that’s changing as investors realize that operating conditions for truck brokers, while still robust, are peaking. Tight truckload capacity (linked to widespread ELD adoption among carriers and the driver shortage) has driven significant spot activity to highway brokers this year, while boosting their pricing power, and positive trends will likely hold throughout the rest of 2018, but comparisons will become quite challenging in 2019 and spot rates have recently pulled back off historic highs seen during the summer months. As of market close on Oct. 24, the shares were trading in fairly valued territory.

In terms of highlights, Echo’s total net revenue increased 28% year over year, driven by solid gains in rates charged to shippers, healthy volume growth (including 5% for truckload), and 19%-plus organic growth in managed transportation business. Gross profit margin (net revenue over gross revenue) expansion also played a role, increasing 20 basis points to 17.2%, despite the cosmetic impact of higher fuel surcharge pass through revenue and an ongoing mix shift to larger LTL-centric managed transportation accounts. Gross margin on truckload business increased more than 90 basis points, with help from the strong pricing environment.

We calculate Echo’s total adjusted operating margin (off net revenue) improved to 15%, versus 7.6% in third-quarter 2017, when the firm was seeing lingering pressure from sluggish contract-pricing conditions and was working through remaining Command integration headwinds. The truck brokerage operating environment has proved quite favorable this year and Echo’s profitably is seeing tailwinds from higher salesforce productivity and leverage from overall net-revenue growth.