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Extraordinary Pricing Conditions Behind J.B. Hunt's Strong Top-Line GrowthMorningstar's Analysis Extraordinary Pricing Conditions Behind J.B. Hunt's Strong Top-Line Growth Matthew Young Equity Analyst Business Strategy and Outlook | by Matthew Young Updated May 21, 2021 At its core, J.B. Hunt is an intermodal marketing company; it contracts with the Class I railroads for the line-haul movement of its containers. It was one of the first truckload carriers to venture into intermodal shipping, forming a partnership with Burlington Northern Santa Fe in the West in 1990. Years later, it forged an agreement with Norfolk Southern in the East. Hunt is now the largest intermodal provider, with a 20%-plus share of a $22 billion-plus industry. The next-largest competitor is Hub Group, followed by Schneider National's intermodal division and XPO Logistics' intermodal unit. Intermodal makes up half of Hunt's total revenue. Hunt isn't immune to downturns, but it's reduced its exposure to the more capital-intensive for-hire truckload business, which represents 30% of sales (including for-hire and dedicated-contract business) versus 60% in 2005. Furthermore, the firm has established a clear leadership position in intermodal shipping in terms of size and service capabilities, while also investing in asset-light truck brokerage and final-mile delivery. The 2018 capacity crunch in the competing truckload market reignited intermodal truck-to-rail conversion activity, particularly in Eastern U.S. corridors. That said, the crunch dissipated and TL rates corrected sharply in 2019, driving down intermodal's value proposition relative to trucking. Thus, 2019 was a hangover year and fallout from pandemic lockdowns further pressured container volume into early 2020. However, truckload capacity has since tightened drastically, contract pricing is on the rise across all modes, and underlying intermodal demand is rebounding sharply on the spike in retail goods consumption (intermodal cargo is mostly consumer goods) and heavy retailer restocking. Hunt is grappling with near-term rail network congestion that's constraining volume, but that should ease as 2021 progresses. We expect 2.5%-3.0% U.S. retail sales growth and conversion trends to support 3.0%-3.5% industry container volume expansion longer term, with 2.0%-2.5% pricing gains on average, though Hunt's intermodal unit should modestly outperform those trends, given its favorable competitive positioning. Economic Moat | by Matthew Young Updated May 21, 2021 Because the for-hire full-truckload industry can be a tough business in which to differentiate, our narrow moat rating for J.B. Hunt primarily stems from the company's intermodal shipping operations, which benefit from a combination of the network effect and scale-based cost advantage. In terms of scale, we think it would be difficult for a small competitor to replicate Hunt's vast in-house drayage capabilities (about 5,650 tractors) and fleet of more than 97,400 53-foot-high cube containers capable of double stacking--by far the largest in the industry. The firm's intermodal container fleet provides preferred access to rail capacity and would be costly to replicate. Preferred access is no small edge, given that the truck-versus-rail decision for shippers is heavily influenced by service levels (in addition to the cost gap). We think this is a key reason Hunt has outperformed its peers in terms of container volume growth over the years. The concept of the network effect suggests that the value of a service becomes more powerful and tougher to replicate with more users. In its core intermodal business, Hunt's large network of shippers and long-standing partnerships with major rail carriers reinforce a compelling value proposition and generate healthy barriers to entry because duplication by small providers with fewer resources would prove difficult. For shippers (customers), the firm's immense customer base affords significant buying power (greater rail capacity access and discounts), and its industry-leading container fleet acts as a highly valuable source of capacity. From the perspective of the Class I rail carriers, Hunt is an attractive source of cargo because of its ability to aggregate fragmented demand across an immense pool of customers looking to capitalize on multimodal capabilities. Fair Value and Profit Drivers | by Matthew Young Updated May 21, 2021 Our fair value estimate is $125 per share. The 2018 truckload capacity crunch drove strong pricing across Hunt's intermodal, trucking, and asset-light highway brokerage operations. However, capacity loosened materially in 2019 on slower U.S. economic growth (especially industrial end markets) and operating conditions softened, while Hunt's intermodal division grappled with with heightened truck competition. The pandemic pushed the hangover into early 2020, but freight demand has since surged off pandemic lows with help from heavy retailer inventory restocking driven by robust U.S. goods consumption. Overall, Hunt's total revenue grew 5% in 2020 despite the pandemic, thanks to a strong rebound in demand and pricing for the trucking and highway brokerage divisions. While intermodal demand bounced off pandemic lows, Hunt's container volume was constrained by rail network congestion and revenue fell 1.5%. Intermodal network imbalance, rising driver wages, and the need to outsource more drayage also tempered margins in 2020. For 2021, we expect total revenue to rise 16% as heightened retailer restocking drives strong demand across all segments throughout the first half, and as intermodal network inefficiencies subside. We also model 120 basis points of adjusted operating margin expansion, to 8.6%, on leverage from what we expect to be unusually healthy contract rate gains across the trucking and intermodal segments (aided by very tight truckload market capacity) and as the firm brings more intermodal drayage activities back in house. We also look for intermodal container repositioning costs to ease and box turns to improve this year as Class I rail service and terminal throughput recalibrate to strong demand levels. We think Hunt is capable of midcycle organic revenue growth in the ballpark of 5%-6%, reflecting 5%-6% growth for intermodal, 4%-5% for the dedicated and for-hire trucking segments, 5% for the final-mile delivery unit, and around 6% for the asset-light truck brokerage operations. Our fair value estimate bakes in a midcycle EBIT margin of 9.0%-9.5%. Risk and Uncertainty | by Matthew Young Updated May 21, 2021 J.B. Hunt's intermodal, trucking, and brokerage volume and pricing are exposed to variability in U.S. macroeconomic conditions. Cyclical downturns in demand compress profitability because excess capacity normally drives providers to slash rates in an attempt to salvage asset utilization, especially in trucking. Further, Hunt's intermodal operations are subject to the service quality standards of its partner Class I rail carriers, which handle the line-haul movement of the firm's containers. While the railroads have made significant infrastructure investments and vastly improved intermodal service options over the past decade, customer satisfaction is often out of Hunt's control in this segment. Changes in diesel fuel costs are largely passed through to shippers in the form of surcharges. Low diesel prices reduce the cost advantage of intermodal relative to trucking, especially on shorter-haul lanes. While the intermodal value proposition remains strong thanks to secular constraints on over-the-road truckload capacity, truck-to-rail conversion activity can decline in the short run when diesel fuel prices plummet. We consider ESG-related risk to be low for J.B.Hunt, but there are a few factors to note. Emissions, fuel efficiency, and other environmental-related regulation has from time to time driven material tractor cost inflation for truckload carriers. Thus, we see a slight risk that future regulatory changes force truckload carriers to adopt electric Class 8 truck technology before it has proved economically beneficial. There will be offsetting factors such as lower maintenance costs, but several variables surrounding payload capacity reductions (depending on battery weight) and resale value, among others, remain uncertain. Additionally, there's some risk that a rising incidence of "nuclear verdicts" (for fatal crashes) against truckers pushes claims-related outflows materially higher and drives persistent insurance cost inflation. Capital Allocation | by Matthew Young Updated May 21, 2021 We assign J.B. Hunt a Standard capital allocation rating, which reflects our overall assessment that the firm's balance sheet is healthy and that its investing (reinvestment and acquisitions) decisions have been reasonable and support its competitive positioning. We also think its shareholder distributions are appropriate. Hunt's highly experienced senior leadership team has diversified the service portfolio and developed an industry-leading competency in intermodal shipping, while prudently allocating capital. Impressive execution has driven relatively consistent market share gains over the years and improvement in the consolidated operating ratio (expenses/revenue) from 95% in the late 1990s to roughly 91% on average during the past five years. Additionally, J.B. Hunt is expanding its presence in the fragmented asset-light highway brokerage industry, which offers market share opportunities for nimble providers that can capitalize on the power of the network effect. While pandemic disruption weighed on 2020 gross and operating margins, Hunt executed admirably in terms of penetrating the highly competitive highway brokerage landscape while boosting its level of transaction automation. Hunt is one of only a handful of traditional asset-based truckload carriers to accomplish this; others include Knight-Swift and Schneider National. In early 2011, longtime CEO Kirk Thompson moved from president and CEO to board chair. Previous chair Wayne Garrison remains a director. Thompson had served as CEO since 1987, overseeing Hunt's transition from a traditional long-haul trucker to an intermodal specialist. Company veteran John Roberts III took the helm as president and CEO following more than a dozen years leading the dedicated contract services division. J.B. Hunt pays a quarterly dividend, which has increased annually over the past decade, and it has a long history of share repurchases. |
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