Wall Street analysts seemed to accept the prospect of negative top line revenue growth from C.H. Robinson (NASDAQ: CHRW) in the second half of the year, but surprisingly weak guidance on net revenues had them asking questions and reducing CHRW's target price.
During the second quarter earnings call on the morning of Wednesday, July 31, Robinson chief executive officer Bob Biesterfeld said that in July (the first month of the third quarter) overall net revenues were trending 8 percent lower, year-over-year.
Analysts wanted to know which division was leading the weakness, and Biesterfeld confirmed that it was North American Surface Transportation (NAST), the truckload, less-than-truckload and intermodal brokerage and management transportation division that accounts for about 73 percent of Robinson's total revenues.
After the call, Susquehanna analyst Bascome Majors cut CHRW's price target to $82 from $87; Deutsche Bank's Amit Mehrotra cut his price target to $90 from $94; and Morgan Stanley's Ravi Shanker cut his target to $64 from $65. Shares of CHRW closed at $83.73 on July 31. Stifel's Bruce Chan left his price target of $95 unchanged.
The tone in investor notes post-call was fairly negative.
"After a tougher than expected 1H, CHRW faces the perfect storm of headwinds going into 2H including cyclical and secular pressures as well as tough cost comps," Shanker wrote.
"The sequential deterioration in net revenue into early 3Q was far more than we'd anticipated, and low/mid-teens EPS declines now feel likely in 2H19," Majors wrote.
"Yesterday CHRW reported weaker-than-expected 2Q results and a disappointing [quarter-to-date] update," Mehrotra wrote.
Stifel's commentary was more constructive than the other investment banks.
Chan characterized the current climate as "a challenging, but hopefully a transitional market, in our view," and pointed out that "management's comments suggest that we've found a bottom."
The bear case, perhaps best articulated by Shanker, picked up on some freight market data suggesting that truckload spot rates are stabilizing and starting to pick back up on some major lanes. FreightWaves has noted that spot rates on the Los Angeles to Dallas lane (DATVF.LAXDAL), one of the highest volume and most volatile lanes in the country, have been sideways since the first week of July.
Robinson's book of business, after holding fairly steady at 65 percent contract and 35 percent spot for years, has shifted to 70 percent contract and 30 percent spot as reported this quarter. As contract or ‘paper' rates continue to be re-bid downwards mid-cycle, a brokerage like C.H. Robinson's NAST will experience revenue headwinds and gross margin compression.
"CHRW was at 70 percent contract mix in 2Q, their highest level in several years," Shanker explained. "This is not a surprise given the drop- off in spot demand and pricing, but such high contract exposure could leave the company exposed to any recovery in spot rates in 2H esp. as it cycles through MSD-HSD declines in contract rate pricing."
The difficulty in navigating volatile freight markets as a publicly traded, non-asset intermediary is essentially this – when freight markets soften, revenues decline but margins widen. But when freight markets accelerate, revenues grow but margins compress. There's always something to pick at, which is why C.H. Robinson's management prefers to focus on net revenue dollars per load rather than simply margins or revenue – net revenue dollars per load is a metric that blends both the absolute pricing environment and the efficiency of the brokerage.
"We tend to manage our business to net revenue dollars per shipment versus net revenue margin just because of all the noise around net revenue margin," said Biesterfeld during the earnings call. "And given the current market conditions and our forecast for the market for the balance of this year though, we would anticipate net revenue dollars on a per load basis to decrease compared to the second half of 2018, where we experienced net revenue dollars on a per load basis well above our 10-year moving average."
The problem is that CHRW's net revenue numbers don't look great and could get worse as the price it charges drops and the cost it pays flattens.
"While 2Q results showed Robinson's flexible non-asset model working well into a softening freight market (EPS growth on revenue declines), their July-TD net revenue trend (-8% Y/Y) showed more stair-step deterioration exiting truckload bid season, after consistently decelerating since late 2018 (4Q18 +13%, 1Q19 +8%, 2Q19 +4%)," Majors wrote.
Chan wrote that the largest, high-quality player in a growing third-party logistics industry is a ‘Buy' despite the current down-cycle.
"Cycle dynamics aside, we see Robinson continuing to operate well, getting better at taking costs out via better technology and processes, and winning market share," Chan concluded.
On the call, Robinson management seemed resigned to an overall lower rate environment and pivoted the conversation toward taking market share, one of Robinson's strategic objectives called out in its investor presentations. By riding the market down, pricing aggressively and growing its customer accounts, Robinson hopes to position itself for a big revenue win during the next up-cycle. It should be noted, though, that CHRW management does not claim that the company will derive any pricing power from increased share – both the brokerage and truckload carrier industries are still far too fragmented for even a growing Robinson to dictate rates to its customers.
Not even a volatile fourth quarter, with surging e-commerce volumes, healthy consumer spending, and shippers in need of trucking capacity will reverse the negative picture for Robinson, Biesterfeld suggested.
"Today, we tend to measure peak across months and not weeks, which frankly makes it much more manageable," Biesterfeld said. "Our belief is that this trend, coupled with the excess capacity, will likely lead to a less robust peak season in the back half of 2019 and 2020."
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