Hub Group, Inc. (HUBG) Earnings Call Transcript & Summary

Good break, but we're going to continue on with next up on our day 2 of our 31st Annual BofA Transportation, Airlines and Industrial Conference. For those new to the room, I'm Ken Hoexter, BofA's Airfreight & Surface Transportation & Marine Shipping analyst. Next up, we welcome Intermodal brokers and logistics carrier, Hub Group with Phil Yeager, President, CEO and Vice Chairman; Kevin Beth, EVP and Chief Financial Officer, joining us here on the stage. Also in the audience from Hub Group is Lorna Williams, hidden over on the left side there, who joined as IR this year. So we welcome all 3 for their first time here at the BofA Transport Conference Hub Group for the second time. So very much looking forward for me to this discussion. With that, Phil, and Kevin, let me turn it over to you for thoughts on the state of the market. I know you have a few slides to kick us off with. And then also as part of your intro, if you can throw in what 3 key takeaways we should leave here with today.

Yes, sure. No, thank you very much for having us. We're excited to be here and really looking forward to the discussion as well. If I think about 3 takeaways everybody has is one, Hub Group has really transformed over the last several years, and that's been leading to some much stronger trough-to-trough financial performance and better returns within the business as well. Second, I would say we also continue to have a rock-solid balance sheet, very strong free cash flow. And third, that's driving our continued investment strategy, which is really focused on organic growth, acquisition-driven growth and now, which is a little bit newer and more consistent return of capital to shareholders. And so we're really excited about how we're positioning the company for the long term and the aligned strategy that we have. And with that, I'll probably just jot in just a quick safe harbor, I hope, I don't know, whatever.

We all read that.

Yes, it was really fast. So we are a supply chain solutions provider this past year 2023, $4.2 billion in revenue, a little bit around a 5% operating margin. It is the second best financial performance that we've had as an organization. 2022 was the next best year. We break ourselves down into 2 key segments: first, being ITS, which you should think of as more of our asset-based solutions. Intermodal is our largest service offering, really what we're known for in the marketplace. We're the second largest provider in the space. We have 50,000 containers, 2,300 drivers. Work with the UP and NS on an exclusive basis and really see some nice opportunities for growth there. We also have a dedicated trucking operation, which is within ITS, high service, long-term contracts, mostly distribution center to store sort of deliveries, about 1,000 drivers, 5,000 pieces of trailing equipment. The other segment, which has been the faster growing and probably more stable portion of our business, is our logistics segment. Recently, we acquired the Final Mile business of Forward Air. That moved us into the top 5 in the big and bulky home delivery business, added a nice appliance capability as well. We have a large truck brokerage operation, which has refrigerated and LTL capabilities that is helping us be more resilient at this point in time, have a great managed transportation business, where we manage over $1 billion of LTL for our customers. And then a great warehousing business as well that we've grown to 11 million square feet across the U.S., mostly LTL consolidation going to inbound into retail. But it's been a great path for us, and we're excited about the future. So where are we going? We set some targets back in 2020 to get to $5.5 billion to $6.5 billion of revenue by 2025 as well as a 4% to 5.5% operating margin. We've been operating well within the operating margin target, obviously, as I referenced on the prior slide, probably have some work to do to get to the revenue targets. But I think as the cycle continues to improve and we continue to execute on our acquisition strategy, we'll be in great shape. I really have 3 core focus areas in our capital. First, investing in the core business, continuing to drive growth in intermodal as well as improving our technology. We're looking at continuing to grow our non-asset logistics businesses, which helps continue to drive strong free cash flow generation, but also help us deepen our value to our customers. Decommoditize our more transactional services like brokerage and intermodal. And then lastly, return capital to shareholders. We have a new leverage target that we've set that we're operating under today. We did a stock split at the beginning of the year, and we're doing now a cash dividend and more consistent share repurchases. So as we think about Hub and why we think we're a good investment, one, we are a leader in the space. We're recognized by our customers, by the industry for our leadership. We have a great management team. We have a very strong strategic plan and focus and continue to generate just significant free cash flow, which positions us for continued investment and success for the long term. So really excited about the opportunities we have and look forward to the discussion.

So let's talk about near-term growth. You talked about growth being down at ITS, down 16% in January, down 6% in February, a little bit worse in March and then a huge upswing of 16% in April. Talk about what you're seeing in the background.

And we referenced this on a prior call that we probably did not move as quickly as we should have on taking price down. I think everybody thought, hopefully, this isn't as long of a cycle and pricing for us is a strong driver of earnings power versus volume. But we were kind of coming over the overhang of that, and that was really what we think will be our last quarter of volume declines. As you referenced, April is going to be up significantly. But I think we also are excited that we've had 4 months in a row now of sequential volume growth. And I think May is trending to be very strong as well. So we're winning a significant amount in bid season. We're well ahead of the targets that we've set by bid. And the interesting thing to me has been the amount of business we're winning in shorter-haul segments like the Local East. That's going to be a big driver of our growth, a lot of conversion from over the road. In my view, one, it's a cost differential, but also the strong service product that we're providing is giving our customers more confidence in converting business from over the road back to intermodal and really utilizing that as a core piece of their supply chain. So we're excited about that.

So let's dig into that on the Intermodal side a bit. So you noted load growth was down 10% overall in the first quarter. Transcon down 6% locally, it's down to local West down 16%. Maybe you want to break that down into what's going on, particularly out West as we now see maybe some of the shift from the East Coast ports, the West Coast ports, we're seeing maybe better volume growth out there. Talk about the potential you see out of that.

Our transcon longer length of haul business has been the most resilient through this down cycle. And so for intermodal, that's really just core lanes for us, and we've done a very nice job in growing that. It's been interesting for me. Typically, when you turn the calendar, we're having to sell actually outbound Southern California capacity and not having to reposition as many containers in. It's been the inverse of that this year. We've been deficit in Southern California all year. So we are getting a benefit from the import demand. I don't think as much because there's a lot more running intact IPI, and that's been a little bit more of a competitive set in those longer lengths of haul. When I think about the short haul, I think there's a good understanding by our customers that the spot market is not going to be at a trough forever that they have gotten a significant benefit out of it. So they're looking for more resilience in their supply chain, more resilience in their capacity. And the fact that we have provided such a great service product in those shorter-haul segments I think, is giving them the confidence to convert that business more permanently. So that's been a really nice indicator of a good driver of our success in bid season, and we think it's going to continue.

So how do you, I guess, compete in that in those West Local East markets, given truck, again, we're talking spot pricing down into the $1.25 range contract rate not quite at that level, but you're more dealing with those customers that would be dealing with contracts. So how do you compete? Where is the gap now or the discount of truck? How wide is that now versus Intermodal? And what would make somebody make that conversion?

I'd say if you look in aggregate, it's probably closer to about 30% would be the contract spread...

Versus normal?

Versus truck. When you see conversion, it's normally in that high 20s, low 30s. So that's, I think, what we're seeing right now. If you think about shorter haul segments, it's probably in the high teens from a differential perspective. And with the consistent service product, that's been enough to convert business. We've done a lot of really good things, though, as a business to better position from a cost structure perspective as well. So our rail contracts now move both up and down from a cost perspective. We've in-sourced a significant amount of our drayage. We've driven down our third-party drayage costs and put in new chassis programs as well that are helping us reduce costs. The other piece with the additional volume is it creates better velocity for us, creates better balance with our drivers, better balance with our containers. So our empty repositioning costs in the first quarter were down over 20%. Our cost per dry was down 15% in the first quarter. And all of that, I think, was due to -- we saw sequentially improving volumes. And with that trend continuing, it continues to reduce our costs.

And I'd just like to add one of the other things we saw was increase of utilization of our containers. So we are up 8% versus fourth quarter utilization. Again, that was one of the goals during the bid season was to make sure that those boxes are moving and turning more often.

So peer competitor, J.B. Hunt noted that they've got 20% excess capacity, presumably stored in yards around the country. How do you think about your excess capacity to store inventory.

We took our stack down about 15% quarter-to-quarter, so Q4 to Q1. So with the sequential volume improvement we needed to unstack, we're trying to get as much as we can out of the existing containers we have out in the fleet right now and trying to avoid unstacking because there is cost related to that. But I think, generally, we're in a similar sort of position where, yes, about 20% is probably the right number. But we are continuing to unstack but once again, trying to get as much utility as we can while keeping service where it needs to be. I think there's a balance you need to want.

Maybe we could step back on Intermodal. Can you set the stage on market size dynamics, both revenue containers in the market?

I mean, obviously, we referenced we're a strong #2 in the market. We're the largest customer, the Union Pacific. We're one of the top 5 customers of the Norfolk Southern and have the second most containers, about 50,000. Some of our competitors are quite larger, about double our size, but we have others that the next closest, the third largest is about half our size. So there are some large gaps between size and we think scale and economics come with that. But I think we've done a lot of really good things recently to position the business. I mentioned on the drayage side, on chassis on our rail contracts. And that's helping us really take on that volume. And I think as we see an inflection in the market will put us in a really good position from a pricing perspective as well.

The one other thing, Ken, is that in our acquisitions and our logistics side, that feeds our Intermodal business. And one of the things we really do a nice job is cross-selling. And some of these customers never used intermodal before. And then when we get them in a consolidation program where we get them in a managed trans program, we could teach them and then they are educated on intermodal and the benefits, and then that has been able to also provide more volume for us that way internally.

It's amazing we've been at this for so long, and yet you're still finding customers that have never used or willingness or still so has it because it's so easy to put on a truck and run point-to-point. And no, I hear you on 50,000 containers. If JB has doubled and you've got Schneider, half your size and then even half that size is neigh. And that's the largest guys out there. You talked about maybe we had mispriced and we shifted price. What's going on in the market now in terms of the shift from price to volume focus?

I think what we've seen is we did need to close the gap on rate. We've done that. We're converting business. Some obviously has to be coming from other intermodal providers, but we think mostly over the road, given how short haul a lot of the wins have been. I think we're now seeing stability in the market. So when we moved, it was around these bids last year. So that's where we feel, okay, our renewals aren't going to be down, really, they're going to be relatively flattish. And then we'll continue to see that, hopefully, trend in the right direction that we're at the end of bid season now as we enter bids going into next year, we're hoping we see that positive inflection in pricing. We haven't seen people get crazy or anything. We've seen it everybody say, "Hey, this is where the market is, and we can win business at these rates and generate a return." And for us, we need to continue to control what we can control and drive our costs down. And that's where a lot of that velocity comes in that I mentioned. I mean our repositioning costs continuing to go down, our driver productivity improving. All that helps us continue to compete.

So you don't break out margins by segment? It's just one overall margin versus intermodal logistics and the like.

We do operating income semi.

So you talked about the 4% to 5.5% goal. You've got some that run higher, some run a little bit lower. Is that market driven? Is it more cost? Or is it you've got opportunities on the revenue side?

Well, I think we've done a lot of really good things to improve the aggregate operating margins of the company. Kevin referenced on our last call, our trough-to-trough operating income is double what it was last down cycle. So we've done, I think, a lot of really good things. Part of that is the diversification of our service offerings, getting more value-added services into our portfolio, getting stickier with our customers. A lot of it is also a lot of the things I've referenced that we've done better with intermodal and just taking out costs, managing our headcount very effectively. I think we're doing a lot of those things very well. I think when you start to get into operating margin benchmarking; everybody calculates it a little bit differently. And so what we really try to focus on is our returns. We run a far more, especially in intermodal, far more asset-light model. We don't own chassis. We outsource somewhere between 25% and 30% of our drayage, which is completely non-asset. 30% of our drivers are independent contractors. So you take all that together, if you actually think about the operating margins, the other people also don't include fuel revenue. So I think that inflates operating margins. But all those things taken together, I think we try to focus on, okay, what's the right return for the business. We don't think going out and buying a bunch of chassis is going to be a very good return investment for us. It's a little higher expense, but it's not really going to generate much of a return on capital. So we really try to focus on that. I'd also just say it helps in our free cash flow profile as well. If you think about why we generate so much more free cash flow, it's a lot of that CapEx is much more limited.

So Kevin, given that diversity, you were talking about truck brokerage, Final Mile, consolidation, fulfillment managed trans. How do you think about where to focus the incremental dollars?

So when we look at our capital, we're always going to look internally first. Are there more equipment that we could be purchasing to make sure that we're positioned to growth that now includes warehouse equipment as well as we've expanded that business? But after that, we're certainly continuing to look at tuck-in acquisitions, mostly on that light asset and that logistics. We like to look for scale. We like to look for other services that we don't have an expertise in. And we think we found that. We always look for cultural fits. We feel that those are best. They slide in really easy. We like those opportunities as I mention cross-selling earlier. And that is something that we feel we can get our services to different customer bases. We're really able to expand and also expanding our current customers into other specialties. So yes, we're continuously looking for M&A. And then after that, of course, is shareholder returns. We made some changes this year with the stock splits and the dividends. And so over $33 million returned to the shareholders in this past quarter between the dividends and the share buyback. So that's sort of our approach. And then the one thing I didn't mention is technology. Our technology is a purpose and it's trying to make not only ourselves more efficient, but bring better service to our customers.

Phil, I want to revisit something you talked about on price. How do we understand your use of price to win volumes versus the market? So obviously, we hear a lot about pricing competition, but you threw in there it's also still rational. Everybody has settled in a bit. How do we outsiders take an understanding of what's going on in the market.

Well, I think what you saw and I think this is a good example of ITS margins actually improving sequentially, right? And to us, that's a really important indicator of what we're trying to do. We're trying to reduce costs and compete more effectively, maintain our margins where they are, make sure we're being diligent on headcount, setting up better contractual frameworks around chassis and rail, in-sourcing more drayage where it makes the most sense, reducing third-party drayage costs. All those things that are helping us compete with over the road. So while maybe it looks like price is down, we're trying to keep margins in a very kind of neutral to up sort of rationale. I think the other piece is as we add that volume in, it further reduces costs through that velocity. We think about it as a margin per load day model. And everything we're trying to win, we take every bid, we overlay it with our network. So what might look like an irrational price to somebody else to me makes perfect sense because I'm filling in an empty repositioning lane or I'm going to help get my driver loaded back those sorts of things that actually help us reduce costs, better serve our customers, improve the existing margins on our business.

So it's about network balance rather than kind of headlines. Pricing, you noted 40% of your annual bid activity was done in the first quarter. Well, I guess that's typical March to May bid season in terms of the trucking market. But given record low truck pricing, how does it look so far? Did expect weak pricing in the first half maybe flattish in the second half? Maybe give a little insight into how that plays out given the bid season.

That's been generally in line with what we've been seeing, and I think we have outperformed. We have by bid a tracker and goal for every single bid we participate in, how much growth we're trying to get, what lanes we want and we have been tracking that pretty diligently, and we're ahead of where we thought we would be at this point in time, which is a great indication of our performance. We're through the vast majority of bids now. We have a few big ones that are left and continue to see similar dynamics to what we experienced earlier. So at least at this point, we're still feeling confident that we're going to outperform our expectations but need to continue to execute here through this 35% that's remaining.