J.B. Hunt Transport Services, Inc. (JBHT) Earnings Call Transcript & Summary

Hey. Good morning, everyone. Welcome. We're continuing with Day 2 of Deutsche Bank's 2021 Transportation Conference, Day 2 of 2. My name is Amit Mehrotra. I'm the transportation and shipping analyst here at Deutsche Bank. I'm really happy to introduce J.B. Hunt. Obviously, a very, very high-quality company. J.B. Hunt also celebrated its 60th year anniversary. So congratulations to the entire J.B. Hunt family for that. Joining for the company are John Kuhlow, Chief Financial Officer; Nick Hobbs, Chief Operating Officer, Head of the J.B. Hunt Dedicated and Final Mile business, so we can really dig into those 2 important pieces of the J.B. Hunt business. And of course, we have Brad Delco joining, J.B. Hunt's Vice President of Finance and Investor Relations.

So thank you to all 3 of you for joining us. We really appreciate it. And Nick, I particularly appreciate you being here. It allows us to kind of dig into the dedicated and final mile business. And people might not know this, but I think final mile is actually the highest return on invested capital business at J.B. Hunt, even more so than brokerage. Maybe brokerage is a close second. So obviously, you've overseen tremendous growth in the dedicated business over the years. I mean if you just look at the revenue trajectory of that business, I think it's over -- growth -- grown by over $1 billion over the last 5 or 6 years or so, all of that pretty much organic. It looks like you're exceeding the 800 to 1,000 truck new additions this year in terms of what you've sold to date. Maybe to begin with, just talk about some of the drivers that are leading to more outsourcing of fleets, how sustainable you think this trajectory is in terms of pretty impressive growth and maybe how the COVID or some of the dislocations in supply chain are actually maybe leading more shippers or -- to actually outsource and consider J.B. Hunt's dedicated business.

All right. Thank you. I appreciate the opportunity to share. I always love talking about dedicated and final mile. So dedicated, I'll start with that. That was a lot of your questions there. We're excited. It's a huge market. We think it's a $55 billion to $60 billion market. And the market we go after, we really target private fleets. And so any company out there that has a private fleet, regardless of the type of trailing equipment, we think they're a target. And so we've got a separate sales force of about 40 people in total that target private fleets. And our strategy, it varies from time to time, but -- on our sales approach. And right now, it is our ability to -- and it always is our ability to execute and our flexibility. And so when we go in and we take over a customer's private fleet, we have a team of engineers that help us to design it more efficiently typically than what they have. And so the average size of our fleets, about 15 to 20 trucks per location. We have some that's 200, 250 trucks, but the average size is about 15. And so we go in and design that really efficiently, execute on that. And so today, the thing that really helps us is our ability to recruit drivers. It's a challenging market, probably the most challenging driver market I've seen in my 37 years here. But we have a tremendous driver personnel team that allows us to go recruit, and so we price our driver pay specific to the market and the activity that, that driver is going to be doing, whether it's unloading the truck, operating Moffetts on the back of flatbeds. So we designed it very specifically. We talk to the customer about that, and so we price it so that we can source drivers. And in today's market, having drivers is gold to the customer. They need their product delivered. And so a lot of private fleets today are really struggling on the driver side. Also, equipment. Equipment is challenging, and so some of them are struggling on the equipment side. So we have relationships with the OEMs that we can source in equipment, and we've got various different levers that we can pull to get equipment. But the key to that all is our contracts are long term. So we average about 4.5 to 5 years as our average contract length. So we have mechanisms in there that there's penalties if you terminate early, unless it's for execution on our side. So these are long-term commitments. It's not, hey, let's -- we need capacity, let's go source this fleet for 6 months or a year. This is really long term. And so we do a great job, and we got a 98% retention rate with our customers. So what really allows us to grow is keep that base and build on top of that base. If you're constantly churning on the bottom, it's hard to really net up, and so we've really executed. Customer value delivery is understanding our customers' needs and really solving for those. And so as we go through when the economy turns, then we start talking to CFOs about their cost of capital and letting us put equipment in, and they go make widgets or whatever they're going to do. And then let's -- help us, we can purchase insurance cheaper than they can, workers' comp insurance. And so it's really a different sale when the economy turns. So we can still grow, maybe not at the rate that we're growing today, but we can still grow even when the economy turns. It's just a different sales process. And so our sales team is very specifically pointed to dedicated, and so we have that ability to flex. And then with COVID, I've had many -- won a large tire manufacturer that shared with us. They were still running their fleet. We'd outsourced one of their locations in the Northeast. COVID hit. We took their fleet of trucks and 40 drivers and moved them over to one of our grocery customers that was surging like crazy. So we gave them credits back at their fleet. So they're not paying for their truck, they were not paying driver wages, we were using that somewhere else. On their private fleet, they were still paying their lease payments, and they were making a decision to [ idle ] employee or lay off my drivers. And so with that flexibility and our density, we have so much flexibility that we can kind of go up and down as each customers' seasonality allow. Some are big in the spring. Some are -- grocery folks are big around holidays. And so we can adjust our fleets and move them and have the flexibility they really can't. So now as we're gaining more and more density, that's even a stronger tie. And then you tie in our ability to tie in with our Intermodal because we bring Intermodal on the front side of the building, do store deliveries a lot of times on the back. So we can drive out empty miles by doing store deliveries on containers. So some of our dedicated fleets will actually pull some of our Intermodal containers, and that's just very, very efficient, and it's hard for some of our competitors to do that.

Well, that's a really powerful example in terms of taking what is a capital-intensive investment for the shipper and turning it into more -- almost volume variable in terms of being able to flex the capacity with the seasonality of their freight. That's really a powerful example. So a couple of questions I wanted to ask on the dedicated business. One is that there's obviously backhaul opportunities in certain dedicated businesses, and my understanding is there's a little bit of a revenue share there in terms of J.B. Hunt maybe being able to capture 20% -- 10%, 20%, 30% of the backhaul revenue opportunity. And that could really make a difference in an environment that's currently high demand, low capacity. Is that built into your contracts? And is that an opportunity you're seeing to kind of drive more revenue and profit in the bottom line of the business?

It's -- I would say it just depends on the customer. And -- but yes, it is typically built into our contracts, particularly where we may be going out over 200 or 300 miles and doing a multi-stop route. The first thing we look for is does the customer have any inbound coming back in, any raw materials or anything, and so we always bring that back in for them because it's usually cheaper than on the one-way market. And so we design that in. But if not, then we work with the 360 platform to see if there's any freight out there. And if there is, then we bring it back. But we always work with our customer because sometimes, they value getting that truck back as opposed to waiting 3 hours and not getting back that night to go out the next day on an outbound shipment for them. They'd just soon have that back. So we talk with our customers and walk through the math, and so it kind of depends on their needs. And so one of the things that we try to educate our customers on that run some of their own fleets, they get enamored and they build their fleets too big, chasing the backhaul like it's really profitable right now. But then when the market flips, they got all these extra trucks and drivers. They've been chasing the market instead of designing the fleet for what it was meant to and then just complementing where it makes sense. And so we see our customers, they go spend capital that they really shouldn't spend. When you really do the math on that, it doesn't make sense for them.

Yes, that makes sense. And I wanted to -- before I get into the margin question, which I'm sure you -- which is interesting, right, because you talked about this wave effect and you're adding a lot of trucks. But before I get into that, you mentioned kind of 15 trucks on average per site. I think like I was looking back at my notes preparing for this call, I think in the conversations that I've had with you or Brad in the past, talked about kind of 600 to 700 sites that account for the 10,000 to 11,000 tractors you have, which was obviously -- triangulates to the 15 to 20 trucks per site. I don't know how important that is for you or like that characteristic of that type of size per site. Because if I look at Werner's dedicated business, which I look at as very different from J.B. Hunt's dedicated business, we're looking at like, I think, like 50, 60, 70 trucks per site or something like that on average across the system. So talk about like why that's an important characteristic for you in terms of having it. It seems like it might be stickier, more diversified, which is obviously better on both fronts. But talk about kind of that dynamic of lower number of tractors per site and why that's an important thing for you guys.

Yes. Our philosophy is we want to be on site with our customers, so we look at where the fleets are going to run out of and really set that up. And what makes sense is can we afford a manager salary over 7, 8, 9, 10 trucks. And so a lot of times, we can because of the execution and management of the drivers and the service requirement. But what we really go after is not necessarily the size but different industries. So as you get across different industries and you see that these customers are running, that's what a small fleet is. It's 15 trucks, 10 trucks. And it's a mom-and-pop business, it's not just big retailers. And so we're very diversified across a wide industry of metals, medical, forestry, timber, ag. We are really diverse, and so it doesn't matter to us what type of industry is. But what that's done is that's allowed us to have a very diverse portfolio that kind of adjust as different things happen in different segments. We have some of the big retailers. That's been our big base. That's probably 25% of our business today, and that's kind of the original where we really started. But what we really go after now and who we really run into is more Ryder, Penske, Ruan and the private fleets themselves is who we run into going after that segment. We do bump into some of the truckers when we're bidding on the retail sites, and -- but we still differentiate ourselves typically around service on those. We're more -- we're a little bit more pricey because we pay our drivers more. And that's really coming into effect today when some of our competitors are struggling to hire drivers and not meeting capacity, we're gaining some sites and growing at some sites because of our ability to attract the drivers. And so we pay our drivers a little bit more. Typically, we pay our managers a little bit more, but we demand a lot more out of them, and that's kind of a winning formula for us.

Okay. So I wanted to talk about margins in dedicated, but I actually wanted to talk about ROIC. I don't know if you've realized this by now, but the public equity investors care more about book margins than they do about ROIC. And I think you guys have learned that the hard way over the last couple of earnings calls. That's just a tongue-in-cheek comment. But first question, just on ROIC, how you look at the business. What are you like -- because the dedicated business is definitely more capital intensive, and you've seen as Intermodal has kind of had lackluster growth and ICS has had this investment phase, that the consolidated returns have come in a little bit as dedicated has become a bigger portion of the business. So I guess when you think about writing new dedicated business, what is the ROIC that you're underwriting? And how good have those assumptions been relative to how the business is going?

Well, I can't share what our ROIC design is, but I will tell you every deal we design is based on ROIC and our targets and our goals. And we come in -- we measure every one of those 600-plus accounts. It's measured every month. I got this red book. Brad makes fun of me, but this red book right here has all those accounts in there and their performance. And so I keep up with that red book and we measure it. And if there's one underperforming, we go address it with the customer. If they're not getting the miles in utilization, we talk about that very specifically. So -- or if the customer's business is off, we talk about moving assets out and putting them somewhere else. So we're very focused on ROIC. And every deal is priced based on that assumption, and our deals are performing very well to our ROIC requirements. And so yes, I fully get all the margin stuff. That's kind of an indicator, I think, but they don't fully look at our blend of assets in there because some of our business is even more asset heavy than others in dedicated. And so you'll see we're very disciplined. If you could see our book, there are certain types of deals that we're probably not as competitive on because the truckers don't fully appreciate the capital of all the trailer requirements. We design a deal and say it has 15 trailers in it or it has 30. And you got to get ROIC on all the equipment, not just a portion of it. And so we're very disciplined around that to make sure -- and our account managers that run those locations, they're measured on that as well. And so that's -- we're very disciplined around that, and I think John and Brad and John Roberts would tell you they're very pleased with our ROIC in dedicated. Even with the start-ups and the impact you're seeing a little bit in our margin, we look at it over the life of the deal, and we constantly are looking at that to make sure that it's matched, and we're very happy with where that's at.

Yes. And I'm going to get to -- I want to get to Intermodal in a hot second. But before I do that, I want to talk about the margins on dedicated. Second quarter was a little bit disappointing, I mean, at least looking outside in. I don't know if you think that's a fair characterization or not. But quite simply, revenues were higher and profits were lower year-on-year. And I know that the second quarter was a little bit of a different scenario where you had a lot of cost inflation and maybe the contract prices take some time to catch up to that. But do you think that dedicated -- I mean now you've got this growth whereas someone -- I think maybe a long time ago on some of my notes, I heard that maybe in the first month of a dedicated contract, you're a 130, 140 OR. Second month, you're at 110 OR. Kind of 4 months in, you're operating where you want to be, and so that wave effect gets created. So are we in a couple of quarter period here where the margins are going to be maybe a little bit more challenged in the business? Or when do you get to that 13% long midpoint of long-term target? Is there opportunity to get to the high end given all the growth you're seeing and the pricing opportunity?

Amit, I'll try addressing some of that and let Nick back clean up here. I've got a lot of feedback after our last quarter about that margin question, and I was very clear. And I said, listen, I hope our third and, heck, even our fourth quarter looks very similar to what we saw in Q2. And the reason being is we added 555 trucks in that quarter, and I think you alluded to it. That does create some noise around startups. There's a lot of costs that we incur before we start recognizing some revenue on some of those deals. But the thing that I'm most proud of, we just updated our long-term margin target in DCS to now 12% to 14%, which was 11% to 13%. And so I think the clearest and best example that I gave folks, if you go back to the third quarter of '18, and that's a clean number because we've removed final mile and recasted those -- that -- the segmented information for third quarter of '18. But in the third quarter of '18, I believe we added slightly more than the 555 trucks, and I believe our EBIT margin was at 10.2%, which I think compares to the 12.7% we just did. And so part of our confidence in raising that long-term margin target range was, hey, the base business is large enough and healthy enough to where we feel like we can grow faster without really putting too much pressure on the margin. So still being within that range and performing that much better than the comparative period of third quarter of '18 when we added maybe just slightly more trucks, I think it says a lot. I think you can also compare the sequential change in margin from our first quarter to second quarter, which I think was about 10 basis points of deterioration. And you go back to that same second to third quarter in '18, I think there was over 250 basis points of sequential OR deterioration. So again, I think that's a testament to execution. And I think we talked about it earlier, you add these trucks, you experience that sort of startup cost. And then you see this wave that comes from sort of the maturation of each of these individual accounts that are being sort of added to the network. So that's how I'd answer that. I don't think anyone inside the 4 walls of J.B. Hunt are disappointed with second quarter performance as it relates to margin because we kind of know what's to come.

Yes, it's a fair point. It's a fair point because if you look at it over that 2-year period, I mean you also have $350 million more revenue in the first half of '21 versus the first half of 2018. And so the profit profile has rerated. That's undeniable. But it looks like just given the growth you're seeing kind of sequentially kind of flattish margins within that 11% -- 13% to 12% to 14% range is probably the right expectation?

There was a lot of work that went into our updated margin targets, 12% to 14% in dedicated, 10% to 12% in Intermodal. And there's reasons why we settled in on those, and that's the right range. As Nick alluded to, if capital intensity changes, well, we need to be at the higher end of that. If capital intensity, right, if we're providing power only and we're using maybe a customer's training equipment, maybe margins need to go lower. Margins don't really dictate the yay or nay on a deal, it's ROIC. And that will always sort of be what determines how we put capital to work and how we grow.

Okay. One quick word on final mile before I ask a few questions on Intermodal. Nick, if I look at the final mile business, you guys have kind of been very aggressive in increasing your footprint there. I mean correct me if I'm wrong, but you guys have looked at that business for a long time, maybe even looking at 3PD back in 2012 or '13 or whenever that business was for sale. But then suddenly, I guess your dedicated customers needed that big and bulky final mile kind of solution. Are you at the point where you've built the final mile business, this agency model, so to speak, which is a great return on invested capital business? Are you at the scale you need to be? Or do you need to make a couple more kind of acquisitions to build out that footprint in final mile?

Yes. Very good question. We are, as you refer to it, a mix shop, I would say, more than just an agency. We're agnostic. We'll price it either way depending on what the customer wants. And some states, where you got the employee misclassification, are probably leaning more on the employee side now. So we have to be flexible to look at that. But from a -- we're always looking, if we can get the right deal at the right price in a segment where we don't have a large enough footprint. We've been expanding in furniture most recently with our last couple of acquisitions. So if we can kind of look at that and find a good fit in a niche with a good customer base that would stay with us during the acquisition, we'll always continue to look at that. But we're seeing a lot of organic growth. Last year is about 50-50. And I think this year, it could be about -- who knows how it could go, but we got a lot of organic growth coming. Organic might be a little bit bigger at this point as we're seeing that come in organic. On the organic, a lot of it, not all of it, but a lot of it up to this point is what you refer to as an agent, I refer to it as a contractor or agency, I say contractor. The other part is, we have some other deals in the hopper that are company-based. And so the customer is very, very attuned and wants tight control and very specific rules. And so -- and they're fine with pricing company. And so we talk to the customer and talk through what their objectives are, and we price it both ways and let them make the decision. But again, it's based on ROIC.

Yes. Okay. I appreciate that. Thanks, Nick. So just pivoting maybe down the line, I want to talk about Intermodal a little bit. I mean we have basically all the rails present at our conference yesterday. It was a pretty depressing day, I got to say. CSX sounded pretty d*** good, but everybody else kind of -- it was tough. It's tough out there, and I'm sure you guys are obviously feeling it in terms of all the service advisories you're putting out. I think you put out more service advisory -- maybe it's a change in strategy about communication, but I feel like you put out more service advisories than I've ever seen you guys put out before. And so I want to talk about, obviously, rail service. But before that, let's just hit a quick highlight. So you guys talked about 3,000 to 4,000 new pieces or new boxes being delivered in the third quarter. Is that still how you're seeing it play out? Are things getting pushed out a little bit? What's the update there? And then you talked about kind of box turns improving a little bit from the 1.65 per month. Just any updates on that in terms of just relative to rail service.

Yes, Amit. I would say 3 to 4 in the third quarter is still on track. Probably, is it being pushed out a little bit? Yes, there were some delays, but I think we contemplated that when we gave you that number or gave the world that number. And then in terms of box turns, Darren alluded to the thaw or hope that we would see a slight uptick. And really, it's impossible for us to predict rail service. And so I think his reasons for providing maybe the slight uptick is let's just assume the world stays as it is, which is pretty bad, to be honest. And we may see just a slight benefit from some of those containers coming in, most of which are loaded that can be -- basically be moved from port to rail and immediately get moving. And that would provide us a little bit of an uptick. But I would say, you heard what the rails said yesterday. I don't think we're going to provide any updates, but we're going to have more containers. We're still working with customers. We're still working with the rails to get better fluidity.

Okay. So if I kind of just...

Hey, let me...

Sorry, go ahead.

That's fine. I just wanted to add, we haven't changed any of our orders for the boxes. But as Brad mentioned, it's mostly just the congestion that's holding things up. And as far as the turns, you heard from the rails, we're doing everything we can to help improve that number, but the congestion both within the network and just getting the boxes over here is still putting pressure on the turn number.

Okay. That's helpful. And so I feel like with giving us those 2 variables, you've given us 2 plus 2, but you're not confirming that it's actually 4 in terms of what the actual load count is going to be. So I'm not the smartest guy in the world, but it seems like it's kind of flattish growth year-over-year in the third quarter. I mean, I'd love for you to kind of tell me I'm wrong, tell me I'm right. Like any color? Because you're giving us all the moving parts. There's a little bit of variability in the box turns, but talk about kind of what that triangulates to in terms of load growth in third quarter.

Amit, we don't give guidance, but I will do a math equation for you, okay? So 3,000 to 4,000, okay, let's just say, mid-quarter convention. So take 3,500, half of that is 1,750. Turn it at 1.6 -- assuming that we turn the same as last quarter, 1.65x a month. It's basically an incremental -- I think it's 8,200 loads sequentially. Compare that to a year ago, I mean flat may be a little bit optimistic.

Got it. See, that wasn't so hard. Brad, that was great.

It takes some math.

Exactly, exactly.

As an accountant, 2 plus 2 always equals 4.

Got it. Okay. Thanks. The other question I wanted to ask, obviously, is pricing, and that's a great story. I mean when I look at the way you guys kind of reprice your contracts, I've always thought of like the second half and the first half of the following year as kind of being the sweet spot in terms of when the full book of business -- the majority of the book of business kind of reflects that opportunity. So do you think year-on-year pricing growth is -- can accelerate in the third quarter? How is that coming in relative to your expectations? I know you've talked about it previously as being a little bit better. I don't know if it's even better versus that. Any update on kind of how the pricing is coming in?

Well, I mean I think the only thing we've really provided is that pricing was trending at the higher end of our expectations. I think we balance some of those -- that commentary. Because believe it or not, costs are trending at the higher end of our expectations around labor and drivers as well as the cost of all this congestion. At the end of Q2, we had roughly 70% of our book repriced. So go back to the end of Q1, it was 40% So that means, on average, about 55% of your book was repriced in Q2. So at the end of Q3, we'll have 100% of our book repriced, and so the average will be 85%. So there will be movement where 55% of our book on average is repriced to 85% in Q3. And so yes, I think you should see the pace or revenue per load also accelerate in terms of the change in Q3 versus Q2.

Yes. And I want to just -- the nuance between repricing and implemented. I mean are you talking about implemented pricing versus not just repricing but implemented some time in the...

Yes, we're talking about implementation, like -- thanks for clarifying. Yes, implemented.