C.H. Robinson (CHRW) reported second-quarter earnings results after the market closed yesterday.
The company announced that diluted earnings per share came in at 78 cents, which was well short of the 90 cents that analysts were expecting.
As a result, CHRW’s stock price dropped more than 9% in after-hours trading before recovering for a more modest 5% decline today.
Let’s review the business and take a closer look at the company’s latest earnings report to see if the price weakness seems justified or if it could be an overreaction.
How Does C.H. Robinson Make Money?
C.H. Robinson is one of the largest third-party logistics companies in the world and has been in business for more than 110 years.
The business essentially acts as a middleman in the transportation industry, helping connect companies that need to ship goods with cost-effective transportation providers that have capacity available via trucks, railroads, airlines, and ships.
C.H. Robinson doesn’t own hard transportation assets such as trucks and is instead a service company that utilizes people and technology to create transportation and supply chain advantages for its customers.
C.H. Robinson essentially books transportation for customers who need to ship goods and takes around a 15% cut of the transaction.
Investors can review my full investment thesis on the company from September 2016 here.
What Happened This Quarter?
The main reason why C.H. Robinson’s results disappointed investors was the margin compression in its North America truckload transportation business.
John Wiehoff, Chairman and Chief Executive Officer of C.H. Robinson, explained, “Our results were significantly impacted by truckload margin compression. Purchased transportation costs increased significantly during the quarter, while much of our customer pricing is committed at relatively flat prices. We have a strong history of honoring our customer contracts while adjusting to the market conditions, and I’m confident we will adapt and execute those changes in the months to come.”
The chart below shows the company’s transportation net revenue margin (gray line) over the past decade, and you can see that it dropped off last quarter.
C.H. Robinson’s transportation margin is the spread between the money it gets paid by customers to help them efficiently ship products and the price it pays transportation companies for their shipping services.
After reaching a multi-year high in 2016, C.H. Robinson’s margin is now more in line with its long-term average.
Forecasting the company’s margin any single quarter is challenging because its prices and costs can shift in different directions due to a number of factors such as fuel costs, truck capacity, and freight volumes.
In this case, management said that the increase in purchase transportation costs was the result of tightening capacity in the marketplace on a year-over-year basis, which happened faster than expected.
While transportation costs increased, prices charged to customers were roughly flat. That’s because around 65% of the company’s customers are on annual contracts that are executed at different times throughout the year.
As a result, C.H. Robinson can’t raise prices on those deals until they come up for renewal, which resulted in a hit to margins when transportation costs increased faster than expected.
Is It News or Noise?
After looking at the chart above, it’s clear that C.H. Robinson’s net revenue margin is volatile and based on a number of factors beyond the company’s control.
Therefore, I would tend to think that a disappointing margin any given quarter is more noise than news and shouldn’t concern long-term investors.
The good news is that management believes the company continued taking market share during the second quarter, the company’s July-to-date net revenue is up 2% year-over-year, and its high-margin global forwarding business is growing nicely.
Management also recently announced at the company’s May 2017 Investor Day that the business targets double-digit earnings per share growth over the long-term.
However, times could be changing in the third-party logistics industry.
It’s worth pointing out that customer pricing (light blue line in the chart above) has been flat to negative since mid-2015, indicating challenging market conditions and perhaps increasing competition for customers in the brokerage business.
If either of these companies becomes a meaningful player in this space, prices and margins could come under pressure.
However, some industry experts are skeptical that Amazon or Uber can become effective competitors, at least not anytime soon.
That’s mostly thanks to the extremely large and fragmented market (C.H. Robinson estimates it has less than 3% market share in North America), C.H. Robinson’s massive two-sided network, and the many challenges of scaling up in this.
DC Velocity provided a relevant excerpt here:
Evan Armstrong, president of Armstrong & Associates, a research consultancy that closely follows brokers and third-party logistics (3PL) providers, said it will be extremely difficult for any newcomer, regardless of its cache, to challenge the established providers, which possess formidable scale and unmatched access to carrier capacity. “This is why anyone’s pitch to charge customers lower margins is countered by the market reality that a large broker such as Coyote or Robinson, with billions of dollars of purchased transportation, can make a 15-percent gross margin on a load, and still price lower than a small broker only making a 10-percent gross margin,” Armstrong said in an e-mail.
Armstrong said he has a metric in mind to determine when Amazon might become a sustainable player in brokerage. “When Amazon has $1 billion of purchased transportation running through its freight brokerage operation, then it might have something disruptive,” he said.
While I’m not losing any sleep over this quarter’s disappointing earnings results, I will continue to keep a close eye on the risk posed by Amazon and Uber to make sure that today’s margin volatility isn’t anything that could become a structural hindrance to C.H. Robinson’s profitability.
Closing Thoughts on C.H. Robinson’s Disappointing Earnings Report
The company’s latest report certainly won’t do much to alleviate investors’ concerns about the logistics market becoming increasingly competitive, especially with rumors that Amazon and Uber are eyeing the industry.
However, it’s also true that the company’s results are rather notorious for fluctuating significantly from one quarter to the next thanks to its noisy margins.
I think it’s too early to proclaim whether or not C.H. Robinson’s current margin level will be sustainable over the long-term because we just don’t know how Amazon and/or Uber might affect the industry’s dynamics over the next few years.
However, I tend to believe that C.H. Robinson’s long-term outlook remains intact thanks to the large and fragmented nature of its markets, its leading scale, the challenges of building an effective two-sided market, its continuous investments in technology, and the continued growth in e-commerce shipping volumes.
With that said, anything can happen over the next several quarters, and it doesn’t sound like the transportation cost situation has gotten any better yet. The good news is that expectations appear to be meaningfully lower going forward.
For example, CHRW’s dividend yield now sits at about 2.8%, which is close to the stock’s highest dividend yield ever since it started trading in the late 1990s.
While CHRW’s forward P/E ratio is near 20, a premium compared to the market’s 17.6 multiple, that would still be a very reasonable price to pay if the company can continue delivering 30%+ returns on capital and growing earnings at a double-digit pace over the long-term as management expects.
C.H. Robinson continues to strike me as a reasonable holding for a diversified dividend growth portfolio, at least until the industry’s long-term profitability picture becomes clearer.
With nearly 20 consecutive years of dividend increases under its belt, I expect the business to continue rewarding income investors with higher payouts for many years to come.