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Morningstar | Seasonal Demand Uptick Muted in J.B. Hunt’s 2Q, but Intermodal Margins Recovering

Narrow-moat intermodal specialist J.B. Hunt's second-quarter revenue before fuel surcharges grew 6.5% year over year. Revenue came in slightly shy of our expectations because the firm intentionally shed unfavorable less-than-truckload business in the brokerage unit (ICS) and intermodal volume fell short on the lingering impact of rail-service disruption (particularly the Class I rails’ precision railroading efforts) earlier this year. Also, the underlying spring seasonal uptick in demand for both the for-hire trucking and intermodal operations proved somewhat muted this year, partly because retail shippers’ inventories are elevated. That said, those factors were partly offset by a strong showing in the dedicated contract segment (DCS). Total operating margin also fell modestly short of our forecast, mostly because of lost leverage from sluggish intermodal volume, and the ramp-up in IT spending at ICS was greater than we anticipated. Intermodal margins recovered a bit sequentially as volume from previous contract wins is onboarding and weather disruption abated.

Overall, we don’t expect to materially alter our DCF-derived $97 fair value estimate. At about $100, the shares are trading in in fairly valued territory relative to our long-term expectations for revenue, margins, and free cash flow growth. In terms of outlook, J.B. Hunt is coming off an incredibly robust 2018, which benefited from unusually tight truckload-market capacity that ignited significant pricing gains and volume tailwinds for Hunt’s asset-based trucking and asset-light highway brokerage segments, while lifting truck-to-rail conversion activity for intermodal. Moderating U.S. economic growth and very tough pricing comparisons are making for a muted operating performance this year, and Class I service disruption in the first half proved a painful incremental headwind for intermodal volume. That said, we expect Hunt’s operating performance to continue to recover as the year progresses.

J.B. Hunt’s flagship intermodal revenue fell 1% in the second quarter (flat for the first half) versus the solid 16% showing for all of 2018. Revenue per load was up 8% (excluding fuel) on the back of continued healthy rate gains during the bidding season, though volume fell 8%, partly due to the lingering impact of Class I precision-railroading efforts earlier this year (including lane closures), coupled with a slightly more muted seasonal uptick in demand this spring—macroeconomic growth is moderating and retail shippers pulled forward a significant amount of imports into 2018 ahead of potential tariffs. That said, given the magnitude of new contract awards during the bidding season, management continues to believe intermodal volume will turn positive on a year-over-year basis by the fourth quarter—we are including that improvement in our 2019 forecasts.

In the asset-based trucking operations, for-hire truckload (JBT) revenue was roughly flat (excluding fuel) as core pricing gains moderated on very tough comparisons, while the tractor fleet declined 2%. Dedicated (DCS) revenue grew 28%, partly driven by the February Cory First acquisition (final-mile services), but customers’ private fleet conversion activity remains a strong tailwind. Asset-light truck brokerage (ICS) gross revenue swung negative year over year (down 4%) as industrywide spot activity pulled back off historic highs seen last year. The firm also shed certain inefficient/unfavorable LTL brokerage business. On the positive side, ICS’ contractual full-truckload volumes are rising.

Relative to the same period last year, we estimate Hunt’s adjusted operating margin (excluding an unusual claims settlement in DCS of $20 million) fell 60 basis points, to 9.4%. The decline stems from softer intermodal volume (lost leverage), rising driver wages, elevated IT investments, and costs associated with the final mile services buildout. We think the firm’s IT investments, including the development of its J.B. Hunt 360 platform (which is pressuring truck brokerage margins), will prove to be a longer-term positive in terms of better data analytics across segments and greater automation in the truck brokerage unit (reducing carrier-sourcing costs). We continue to expect modest margin improvement in the second half and in 2020 as intermodal volume trends recover.