Description

Short: c.h. robinson (CHRW)

Short Investment Type: 1) Cyclical Over-earner 2) Secular Decliner due to Technological Disintermediation 

Fulcrum Issues: 1) Supply/demand tightness in trucking market 2) Impact of Electronic Logging Device (“ELD”) mandate on TL market 3) Adoption of smartphone-driven brokerage alternatives

Business Description: C.H. Robinson (“CHRW”) is the largest truck brokerage firm in the United States.  It connects 68,000 transportation carriers with shippers across the globe, providing freight brokerage (#1 share) and logistics services (#4 share) up to the point of fully managing customers’ supply chains. Annual revenue is 50%/50% spot vs. contracted and 90%/10% US vs. international.  The bulk of sales come from Truckload (“TL”, 61% of sales) and Less-than-truckload (“LTL”, 17% of sales) industries, with <20% of sales generated in ocean/air/other logistics.  83% of TL sales were transported by carriers with <100 trucks with services skewing increasingly to smaller players in the industry as larger players develop in-house brokerage.  End market mix is widespread and diversified with manufacturing (25% of sales), food and beverage (20%) and chemicals (15%) representing the Company’s top 3 exposures.  Customer concentration is limited with CHRW’s largest customer representing just 2% of sales and the top 500 representing 42% of sales.

Thesis: CHRW has been the beneficiary of a two-year “golden age” in truck brokerage, which is on the cusp of an abrupt and painful conclusion.  Shorting CHRW provides an opportunity to get paid on the truck brokerage cycle flipping, while we wait for new technology to gain traction and put the Company into secular decline.  We expect net revenue margin compression for at least the next 18 months as contract truck prices reset in a more balanced freight environment. 

In addition, new electronic logging device regulations go into effect in December 2017 and will fall disproportionately on the smaller truckers that comprise the bulk of CHRW customers.  We expect many of them to go out of business and further weigh on volumes/pricing on top of cycle pressure.  Finally, new technology designed to cut out the middleman and do what truck brokers do for a fraction of the price (“the uberization of trucking”) are well-capitalized and gaining traction among shippers/carriers.  We expect these start-ups to steal share from brokers and compete away margins by offering to connect shippers and carriers in a more efficient and less costly manner. 

Risk/Reward

We believe CHRW has 34% downside to ~$48 in a base case in which the cycle turns slowly, driving slowing contracted revenue growth and 300 bps of net margin compression.  In a more compelling downside case, in which the cycle flips more abruptly and new technologies drive secular decline in the truck broker industry (i.e. multiple compression in spite of trough earnings), $38.50 (-48%) is a likely scenario. If the brokerage industry accelerates and we are wrong about the cycle, meaning the market ignores any secular threat from ELD and the uberization of the trucking, upside to ~$80.00 (+10%) is our view of risk in the bull case. 

Investment Rationale

Cyclical Over-earner – An Unusually Profitable Upcycle

Truck brokers are most valuable at the extremes – when there is such a shortage of space on trucks that brokers are needed to find capacity for shippers or when there is such a surplus of space on trucks that carriers are willing to pay brokers to fill their trucks. The harsh winter of 2014 led to the former with demand outstripping supply and near-immediate spikes in spot pricing for truckload carriers.  CHRW saw an increase in demand for their services, but is also subject to spiking spot prices on the cost side of its ledger.  Therefore, it wasn’t until Q1 2015 when the stars really aligned for the Company.  Annual truckload contracts, which were tied to the aforementioned spiking spot prices, were signed before the Q1 2015 freight market peak.  Consequently, CHRW locked in top-line contracts at inflated pricing just before the market reversed to an oversupplied state.  Spot prices fell off a cliff and contracted TL volumes gained share of shrinking over-road volumes.  CHRW’s primary cost inputs – fuel and TL spot prices – declined precipitously while contracted rates that were set in tighter markets persisted, driving net revenue margins to peak levels. 

The contract/spot spread troughed just before the aforementioned “golden age” began with the unseasonable cold winter of 2014.  These spreads reached post-Great Recession highs in Q1 2016 but have started to flip.

The Cycle Flipping and So Will CHRW Earnings

As we enter 2017, signs have emerged that the “golden age” of brokers will reverse into a cyclical decline.  As mentioned above, truckload sentiment and pricing leads the truck broker industry, determining at what rate annual contracts will be set for the following year.  For the past 18 months, TL utilization and pricing has been in steady decline, which has taken time to flow through to the brokers as the industry becomes comfortable that winter 2014 conditions and driver shortages were a short-term blip as opposed to a longer-term industry phenomenon. 

Below are a series of charts that show 1) public TL carrier pricing 2) Cass shipment index cyclicality and 3)dry van contract pricing, all of which peaked in 2H 2014-2015 on the heels of winter 2014.

         

Technological Disintermediation will put CHRW into Secular Decline

CHRW is most certainly a cyclical Company and 1H 2016 represented the peak of their cycle.  However, in addition to qualifying as cyclical over earner, CHRW also screams short to us because of several secular trends that we believe will disintermediate the Company’s services. 

First, the burden of Electronic Logging Device (“ELD”) mandates on the TL market will fall disproportionately on smaller trucking companies that have yet to make the required capital investment to comply with new laws.  These on-board recorders essentially ensure truck drivers aren’t driving long hours without breaks, posing a threat to other drivers on the highway.  We expect a significant number of these truckers to go out of business as the impact of limiting hours-of-service (“HOS”) hits top line (small truckers regularly drive 24 hours straight) and the cost of buying the actual onboard recorders undermines already thin margins/cash balances.  The market is focused on the fact that the ELD mandate will remove an estimated 3-10% of capacity from the current fleet and what that might mean for balancing supply/demand in the trucking market (and TL prices). However, underappreciated by investors is that this capacity reduction will come from the small-to-medium-sized carriers that comprise the majority of TL capacity for brokers.  In fact, single-truck operators provide 1.4 million or 61% of the 2.4 million Class 8 trucks serving the “for-hire” industry.  Factoring in fleets of fewer than 20 trucks, the figure rises to almost 80%. There’s also some question as to who holds liability for ELD compliance checking, which could drive CHRW margins down in the event that brokers must certify compliance. 

CHRW’s scale (65-70k carriers in network) will prove to be a competitive disadvantage when ELD officially hits next December (final appeal lost on 11/1).  An increasing portion of freight will move with large truckers that don’t use brokers and/or move with trucking companies that are more sophisticated and have greater pricing power over CHRW.  Therefore, CHRW will feel the pain of ELD through top-line weakness as customers fall away and broker pricing takes a hit, even as TL supply/demand tightens.

A second secular disintermediator of CHRW’s brokerage services is the idea of an “uberization” of trucking markets.  Trucking remains an antiquated operation.  Small trucking fleets often operate with pen and paper, phone calls, and faxes and don’t have the resources to quickly fill empty trucks at the last minute.  ~28% of all truck miles are at least partially empty according to the National Private Truck Council.  Large TL carriers average 11% empty miles, meaning the vast majority of inefficiency exists within smaller carriers.  Therefore, small carriers are more likely to pay brokers such as CHRW to minimize these “empty miles” by finding shippers to fill trucks almost real-time (for a hefty fee).  Recognizing the inefficiency behind this, a growing number of venture-backed, non-traditional approaches have emerged to connect shippers and trucking companies real-time at a fraction of the cost that brokers charge.   Similar to Uber disintermediating taxi cabs, smartphone apps in the transportation industry can solve the real-time information gap (currently filled by brokers) and match supply with demand with the click of a button.  This promotes a level of price transparency not available to the transportation industry currently as brokers set the price in a “black box”.  New offerings provide for rate negotiation and carrier selection as both carriers and shippers can see the number of available trucks and loads in a specific lane.  95% of commercial truck drivers now have a smartphone and can therefore find potential shipments to fill space in their trucks right from the cab of their big rigs.  Finally, these products also allow for quicker payment, which currently takes 15-30 days when a broker runs the process.  Near immediate settlement of the transaction would eliminate trucking carriers’ reliance on factoring companies, an attractive development that is likely to drive adoption.   

Below is a list of some of the more well-known “Uber for trucking” offerings.

Our research was split 50/50 between experts that believed these “Uber for Freight” offerings were a near-term threat versus those that didn’t.  Two venture-backed start-ups, Convoy and Transfix, as well as UberFreight seem to have the leg up on the competition.  Cargomatics, TruckerPath, and CargoChief received less rave reviews, even from their own founders.

• Convoy

• Carrier app that give away for free (includes preferred lanes, fuel efficiency offerings, etc.) is then matched with a free shipper portal that resembles Kayak in pricing freight between destinations

• Jeff Bezos is investor, Board member, and good friend of CEOs; plan is to get big customers like BBY and Mattel by leveraging Board level relationships (also SBUX exec) and eventually, you’ll see Amazon start to use it

• Have employed conservative growth strategy since outset, the antithesis of Cargomatics, to build carrier density before aggressively pursuing shipper freight

• Transfix

• Started 18 months ago, already do $50mm revenue and will do $100mm next year

• Use app to match shippers with freight, broker without the overhead basically

• 3 Fortune 100s have reached out to Transfix to set up meetings in the past month; these are in-bound inquiries

• Trials for shippers

• 15 ongoing currently, all in 96-100% on-time delivery, strong KPIs

• Shippers start at 5% of freight (might outsource 30% of freight to brokers currently) and all 15 currently in trial plan to increase from that 5% (so at a minimum stealing 1/6 of traditional broker business)

• Just had first large retailer outsource all of their broker freight to Transfix which was a significant development

• There is no scale limit on how much Transfix can service

• Uberfreight

• According to everyone we talked to, UberFreight is the “elephant in the room”

• Uber prides themselves on having the best algorithms that match carriers/freight, best tech on the market

• Getting pretty close to committing to their offering

• 86 people and growing on the operations side as of today

• In the market actively hiring on the sales side with plans for a full team by the end of Q1 2017

• Are hiring away some talented people on the broker side to build out transportation expertise

• Otto (owned by Uber) gives them very real presence/instant credibility, which is going to drive some pretty mature companies to make the investment as soon as Uber rolls it out

• Cargomatics

• Hanging by thread; without investors bailing them out, may fail soon

• They were the first to market but mismanaged the roll out

• Cargomatics is a bunch tech guys trying to do transportation/logistics

• Got caught in the growth vs. profitability debate

• CEO doesn’t think they compete against CHRW because their short-haul focus rarely runs into brokers

• Cargo Chief

• Freight broker that targets small fleets and incorporates more technology than traditional brokers (but aren’t an app like Transfix)

• CEO doesn’t think they compete against CHRW as so focused on SMBs

• Trucker Path
• Trying to create an online market place through a heavily-used app (400k drivers) that has basically replaced CB radios (gives weigh station congestion, traffic updates, restaurant recs)

• They are struggling to get shippers to list freight on the app, which drives a chicken and egg scenario:

• If going to charge truckers for app, they need to see freight when they get on, but can’t get freight without the carriers on the app

• In desperation for loads, they are contracting with brokers to get those loads, which means they aren’t all that differentiated from traditional brokers

Below is a summary of conflicting views from research experts.

Imminent Threat

• Convoy Employee: We’ve reached a tipping point.  Early adopters started using Convoy 1-2 years ago.  However, big, old companies have are starting to test Convoy.  Unilever for example just did a 30-day trial and is increasing its freight allocation to Convoy as we speak.

• Convoy Employee: Every Fortune 500 company in the world is knocking on Convoy’s door.  Jeff Bezos is a good friend of our CEO’s and he’s on our Board.  Guess what happens when he turns on Amazon volumes to Convoy?

• Transfix Employee: We can work on much smaller margins because of our technology.  We are matching freight to carriers using machines for $60 versus CHRW who is paying labor $200+ to make calls/send faxes to arrange shipments.

• Transfix Employee: 3 Fortune 100s have reached out to Transfix to set up a meeting in the past month.  These are in-bound inquiries.

• CHRW Competitor (Traditional Broker): If you’d asked me 6 months ago about Transfix/Convoy, I’d have scoffed and moved on.  It’s another broker except they have an app.  However, we have a very larger shipper in CPG that is using Uber in trial mode right now.  They’ve leaned it up so they can offer service for a fraction of the price that we can.

• Cargo Chief Founder: The trucking industry is allergic to technology.  But prices have come down so much that people will start to adopt.  Big TMS used to cost hundreds of thousands of dollars, but cloud TMS is now free because companies like Cargo Chief just want the data.

• Convoy Employee: Two years ago, these apps wouldn’t have been a possibility.  However, 80+% of truck drivers now have smartphones.  The cost of carrier plans has declined and service in rural areas has improved.

Not a Threat

• Cargo Chief Founder: Cargo Chief isn’t competing against CHRW at all right now.  It’s actually the carrier that we are stealing share from.  A shipper calls Cargo Chief and instead of using Schneider, Cargo Chief places freight with a small carrier for lower price.  I don’t know why you’d call us instead of CHRW, because we don’t have the scale that they do.

• Cargomatics Founder: Real disruption will only really happen when autonomous vehicles hit.  We take out 3-5% of the cost for shippers.  Eliminating truck drivers takes out 50% of shipper/carrier costs.

• Koch Transport Manager: The challenge will be the concept of drop and hook.  We are not going to just allow anyone to move our trailers.  You better have a perfectly efficient process because you are eating up our driver’s 14 hours if you aren’t ready to hook on immediately.  We’ll charge you for that.

• CHRW Competitor (Traditional Broker): I’m skeptical because the real world will get in the way. It’s Friday afternoon at quarter’s end and WMT needs to ship all this stuff for Monday delivery to stores.  Can they really accomplish that without people?

Our downside and worst cases contemplate a threat from these services and based on the anecdotes listed above, we believe ascribing 35% probability to their occurrence is more than conservative.  We also expect the Uberization of Trucking competitive threat to be priced in far in advance of it showing up in CHRW results, which also drives our excitement for this short.

Finally, and most certainly longer term in nature compared to ELD and uber-like brokerage alternatives, the use of self-driving trucks over the next decade could completely blow up the supply/demand dynamics of the trucking industry.  The aforementioned uber-like technologies, should they gain traction, will most certainly reduce empty miles in transportation industries, creating supply in an often supply-constrained industry. However, moreso than trucks, driver shortages put the most pressure on the supply/demand balance in times of peak demand.  People don’t grow up to be truck drivers anymore and some estimate for every 1 new driver that enters the industry, 4 are reaching retiring age or leaving to drive an Uber and remain close to their families.  Ironically enough, it was Uber (through its ownership of Otto) that last month shipped the first commercial load via self-driving truck – a shipment of 50,000 Budweiser cans over 100 miles of roadway between Loveland, Colorado and Colorado Springs. (http://www.theverge.com/2016/10/25/13381246/otto-self-driving-truck-budweiser-first-shipment-uber) Should self-driving trucks become commonplace over the next 5-10 years, the need for brokers (and truck drivers) would be largely eliminated. 

In summary, we recognize that trucking companies are slow to change and that self-driving trucks and new smart phone apps could be a decade or more away from impacting the industry.  However, we like the set up here.  The truck broker cycle is flipping, meaning top-line and margins will be under pressure for the next several years.  This alone is likely to drive downside in CHRW shares.  In the meantime, well-capitalized, smart people are working to solve inefficiencies that could completely disintermediate truck brokers.  One can wait for that secular decline as the cyclical decline pays you to be patient.

Capital Allocation Record

In January 2015, CHRW acquired private brokerage firm Freightquote, headquartered in Kansas City, Missouri for $365mm in cash. Freightquote’s results are included within the LTL segment, although it maintains a separate brand name. Freightquote added ~1,000 employees (representing 9% of C.H.’s average headcount growth in 4Q15) to the enterprise and serves ~80,000 customers.  Prior to Freightquote, CHRW also acquired nearly two dozen companies since going public in 1997. The most material of late was freight forwarder Phoenix in 2012 (to build necessary scale for ocean freight), and management has stated that Phoenix’s growth met its expectations several years ahead of schedule.  In 2014, management introduced a goal to return ~90% of net income to shareholders each year. The Company’s dividend yield is currently 2.3% and since the beginning of 2013, CHRW has repurchased 11% of its shares outstanding, buying back over $1 billion of stock.  Buybacks are already in street numbers going forward, which we view to be a positive as capital allocation is unlikely to drive significant upside beyond already high expectations for capital return.

Valuation

CHRW trades at 20.5x forward EPS, which compares to a 5-year median of 20.5x. 

And yet, on a historical PEG basis, this multiple far from justifies growth over the next 12-24 months.  We expect multiple compression to mid-cycle levels in the 16-17x range over the next year.

Catalyst

- Change in truck brokerage cycle

- Enforcement of ELD regulations

- Dis-intermediation by "uber-like" services