Cowen Joins Chorus Of Trucking Bears But Says 3PLs Are Safe
A freight broker at Echo Global Logistics.
Last Thursday equities analysts from investment bank Cowen Inc. (Nasdaq: COWN) issued a trucking industry update following visits to Echo Global Logistics, Inc. (Nasdaq: ECHO), HUB Group Inc (Nasdaq: HUBG), and Redwood Logistics in Chicago. Cautious guidance from Echo's senior management on truckload rates in 2019 contributed to Cowen's somewhat bearish forecast, which falls in line with Morgan Stanley's recent projections.
"Trucking capacity remains relatively tight from a historical perspective but definitely has softened of late. TL pricing is expected to increase 0 percent -3 percent in '19, a negative sign for TL stocks," wrote Cowen analysts Jason Seidl and Matt Elkott.
Cowen thinks—and we agree—that 3PLs and brokerages are generally in a safer position in a softening market than asset-based carriers. Currently brokerages are enjoying a wide (20 to 23 cents per mile) delta between average ‘contract' and spot rates, and incremental additions to trucking capacity, especially in small fleets that move brokered freight, have made it even easier for 3PLs to find trucks. In Cowen's view, a stabilizing, flat market where contract and spot rates converge poses a more serious downside risk to brokerages than a somewhat volatile softening market, where prices for capacity fall faster than shippers can react.
"ECHO generally locks into contract rates between Dec and March," Cowen said. "ECHO is able to purchase transportation a little cheaper now, and as a result, net revenue margin has held up well. Expect that to change a bit to the downside if we get a flat market. If the market declines, however, we would expect gross margin gains, particularly in the first half of 2019."
The relationship between ‘contract' and ‘spot' rates for trucking capacity is more complex than trucking companies and Wall Street analysts like to admit. ‘Contract' freight is, of course, not a legal commitment to move a load or pay; it just refers to a rate that both shipper and carrier have said they can accept. Far more important to a trucking carrier or asset-light logistics provider than average ‘contract' prices is the company's position on a shipper's routing guide. If a shipper has five transportation providers listed in order of preference on its routing guide, there could be a 100 percent difference in price between the first and fifth position.
Tender rejections—also called ‘turndowns'—tell us about carrier sentiment and where in the routing guide shippers are finding capacity. As carrier reject loads tendered by shippers, the shippers work down their routing guides and the load gradually becomes more expensive. See the SONAR chart below, which shows daily levels for national tender rejections (OTRI.USA). With turndowns in the basement, we can infer that carriers in the first position in the routing guide, usually the cheapest option, are taking the freight. Therefore, instead of quoting ‘average' ‘contract' rates, industry analysts should be thinking about the very lowest part of that range, which will be much closer to spot.
Turndowns have fallen off a cliff since the beginning of July. (Chart: FreightWaves SONAR)
In an October 26 note on Echo's Q3 results, Stifel Financial Corp (Nyse: SF) analyst Bruce Chan was similarly optimistic about ECHO's business in a variety of market conditions.
"We anticipate low-to-mid-single-digit revenue growth through 2019 as persistent structural capacity tightness drives modest pricing gains as well as continued demand for Echo's services," Chan wrote. "But if assuming a slow-growing or stagnating gross revenue line, one would also assume an offsetting expansion in gross margin, in our view."
Stifel set ECHO's price target at $38, or 18.5x estimated 2020 EPS of $2.07; Cowen's price target for ECHO shares is $40.
Cowen also heard from executives at Redwood Logistics about their views on rates going into next year.
"In terms of rate increases in [the first half of 2019], management believes that most customers are attempting to roll to June with same rates, at which point a low single digit increase is likely," Cowen wrote.
Finally, Seidl and Elkott were bullish on Hub Group, given continued demand for intermodal services as port activity and railroad intermodal volumes are expected to grow next year. Cowen said that Hub Group expected price increases in the 5 percent range, and hoped that Union Pacific Corporation (Nyse: UNP) and Norfolk Southern Corp's (Nyse: NSC) adoption of precision scheduled railroading-inspired ‘Hunter principles' would not disrupt service as severely as what CSX Corporation (Nyse: CSX) experienced last year.
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