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

Good morning, everyone. Welcome back to day 3 of the Laguna Conference. And we're very happy to kick off the transportation content today with J.B. Hunt. And joining us today is Darren Field, President and EVP of Intermodal; Brad Delco, VP of Finance and IR; and John Kuhlow, CFO, who will be joining us in a moment. Gentlemen, thanks so much for joining us this morning.

Thank you, Ravi.

Thanks, Ravi.

So before I kick off, I need to point out that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Also before we kick off, Katy, I think you're not on mute, so you can just go on mute that will be great. And also for the audience, please submit your questions for the management team via our webcast, and I can pass those questions along to Darren, Brad and John. So gentlemen, thanks again for joining us. Obviously, still a very, very strong environment for freight transportation and pretty much every mode of freight transportation. Clearly, that's been a big theme of the conference so far, both from the transportation companies that have presented, but from others as well. Darren, maybe you can kick off with some kind of broad thoughts on how things are trending today relative to maybe 3 months ago? Clearly, we've had some weather issues that have thrown more wrenches in the works, if you will. So how are things running right now relative to a normalized environment?

Sure. Thanks, Ravi. I would say the hurricane that came through didn't have a significant impact on the Intermodal network, thankfully. I think that certainly demand for Highway Services to resupply emergency water and consumer products to help people through in a difficult time has been a capacity displacement event. So that's something that seems to happen a couple of times a year anymore. And certainly, the transportation industry and the highway solutions side is impacted by that. I think from an Intermodal perspective, things are kind of similar to 3 months, if not, maybe just slightly more difficult on the velocity front. And by that, I mean, rail velocity has not improved in 3 months. I think if anything, it's slightly under pressure. And certainly, our customer unloading activity continues to be a significant challenge for us, and that has ultimately caused sort of a loss of container capacity. When the railroad slowed down, customers unload time has slowed down and all of those -- both of those events certainly creates a loss of velocity and it ultimately creates a loss in our container capacity. So that's been a challenge for us. The demand environment remains very strong. Our customers are leaning into us, asking for solutions. We are really letting the enterprise speak for ourself where Intermodal can and is the right solution, and we can produce the capacity. We're working hard to provide those solutions at this point. There are many cases where speed to the shelf is really important, and that has allowed us to really lean into our highways solutions team, whether it's brokerage and ICS or our 360box program in our JBT segment. We're working hard to keep our solutions out in front of the customers so that we can help provide capacity. And it's important to us to look for a time in the future when velocity will improve and we can convert some loads back to Intermodal that really need and should be Intermodal and the customers want the intermodal, but capacity at the moment has been preventing that from happening. So I think we're doing a lot of hard work there. The driver front remains extremely difficult. I think our organization has reacted well, and we have really ramped up our recruiting efforts. I don't want to suggest that it's easy. It's not. It's extremely difficult. I would -- in my 27-year career, I think driver hiring is the most difficult we have ever seen it. And I don't anticipate that easing anytime soon. That's here to stay for a very long time. So I'll stop there and let you maybe ask some more questions.

Great. And that was a great summary. Thank you for that. Can we just drill a little bit deeper into these congestion issues, because you've obviously been very vocal about that. Others in the industry have been very vocal about that. Can we just try and get to kind of the root -- I see John has joined as well. Can we just get to the root of what the problem here might be? Because I think there's still some uncertainty or lack of visibility there. I think we were doing a wrap-up event with clients yesterday of day 2 of the conference, and we kind of realized that the shippers who had presented were pointing the fingers at the railroads. The railroads that presented were pointing the fingers at drayage. And the other important company that presented yesterday was pointing the finger at the shipper saying that, hey -- each one is saying the congestion is driven by the other guy. So is it all 3? Is all 3 true? Is it one or the other, kind of how would you characterize it?

Yes, I think it is all 3. Now I want to start with maybe an overarching challenge in the labor front. We need equipment to turn faster, to cycle faster at our customers. That frees up a container to go back in the gate, hopefully with a load on it, but in the international community, it's likely to go in empty, freeing up a chassis so that the railroad can unload another container and do the same thing over again. The asset base in the supply chain for Intermodal, particularly in maybe international, is even worse than domestic where the velocity of that equipment has slowed down, and a lot of that is caused by whether it is a shortage of drivers for the drayage community, a shortage of labor at customer warehouses to unload or in some cases, maybe even a shortage of equipment or labor at rail terminals or COVID disruptions. There's other elements. You've got international imports coming in, in kind of surges. So a Chinese port may close for -- and has over the course of the summer for a week or 2, and then it creates a massive backlog and then you have multiple vessels arriving. And then there's just this sort of roller coaster effect where we've had some moments where maybe the demand for a week or 2 actually wasn't significant in California, but in the inland points, there was still significant backlog of getting deliveries made, getting containers unloaded, reproducing chassis and just improving cycle time. So yes, I'm not surprised that all the parties are pointing at another one. I do believe strongly that everybody has a responsibility. I think that the sooner we can get cargo into warehouses or on the shelf or into someone's home or point of consumption, that frees up capacity. And that's a major component of what's going on in the system. The railroads need their flatcar supply velocity to improve in order to move more traffic. And right now, at the destination ends, particularly in international, there's a lot of delays in getting those deliveries made. So terminal dwell at the back end has significantly grown. And so I'm going to point and try to support the rail providers and say, we really need to get that equipment turned faster in order to create more capacity for the rail system to improve.

Got it. And 1 way to incentivize that behavior, obviously, is to charge accessorials and you guys have made that a fairly big focus. Can you talk about how successful you've been at collecting those accessorials? Has that driven any notable change in customer behavior?

Yes. I think that when we announced the 12,000 container purchase this year, and at the time that we did that, we felt confident in the demand environment, the need for those containers, the -- all of the challenges that come with getting them here and the cost in order to transport the newbuilds into North America is significantly elevated, while international import is such a difficult channel today. And when we went out and we purchased the equipment and yet the customer base was really falling behind on this unloading behavior, we did implement a charge program in order to incentivize the customers. We would much rather have loads. I want to be extremely clear on that. We would rather be moving more loads, turning the equipment faster. But in the event that the customer is creating a challenge for us, we're going to ask them to participate in covering the excess cost that we took on in order to get that equipment here and operate our business and produce the returns that we anticipate for the capital we're spending in order -- in that investment. So while I don't want to call it successful or unsuccessful, Ravi, I think that those discussions are difficult. We don't like having them. The customers are, in some cases, they're upset about it. They don't want to pay that any more than we want to charge it. All of us want to move more loads. But certainly, we have implemented those programs and they continue today. And as soon as the customers can unload faster, they are 100% the beneficiary and those costs go away for them.

Understood. So just kind of moving on to the broader price environment. I mean, clearly, kind of with everything being very tight in both Intermodal and trucking, it's a pretty beneficial price environment for you guys. So maybe specifically in the Intermodal business. Again, we heard some of the trucking companies yesterday have some pretty high expectations for pricing in 2022. What are some of the early indications you have about what pricing could look like in the Intermodal business in 2022 for you guys?

Yes. And I appreciate the question. I wish my crystal ball was excellent and I could give you a real high-quality response to that. Ravi, I think it's super early to tell. There are so many questions remaining. You've got this -- you've got a new dynamic where some unemployment benefits are ending. You may have an improvement in the labor supply. We don't know. We're waiting to see. At the end of the day, we have had significant cost pressure in 2021. We have seen that, that has been a part of the pricing discussion in this year. I don't know what to anticipate in 2022 related to those costs. Can we get a velocity pick up out of the rail system, out of our customer unloading, out of our drayage activity because we could be more productive when the velocity of the equipment is better? If all of those things are possible, certainly the pricing cycle, I would think, would reflect that. But at this point, it's hard to see a world that has cost going down. It feels a lot like cost will likely continue to increase. And as costs are increasing, I don't believe the market has any choice but to pass those costs along to the customer, and that shows up in the form of pricing.

Got it. Darren, entirely appreciate that it's incredibly hard to forecast anything, certainly sitting in this seat, that the last 18 months have been incredibly challenging. But can I just ask you kind of what does the plan B for 2022? So let's say that labor situation does not improve and the kind of the factors driving the current congestion continue. Is it likely to be status quo from this point forward and is this the new normal? Or is there something that, again, you, your customers and the railroads together can do to help kind of improve the fluidity of the network, even if that labor kind of does not really come back the way it needs to?

Sure. Great question. And we're working on those projects all day every day right now. The first step is a 12,000-container purchase and then the chassis fleet required in order to support those containers as we've -- we do have more Intermodal drivers and trucks out there handling our drayage activity today than we did a year ago, and we'll continue to focus on our recruitment efforts in order to drive our ability to at least sustain the current level of productivity that we have. That gives us a growth opportunity. I think that the ability to go out and secure lease properties to use as storage yards for these -- in order to create some fluidity at rail terminals. If the system can't provide an improvement in velocity naturally, we have to take unnatural acts in order to do that, and that can be through securing additional real estate to park equipment on. I know that sounds crazy, but that's what it takes in order to drive more volume through the rail system, and we'll continue to look for those efforts. We are engaged with all of our rail providers to help eliminate dwell at our terminals. We're engaged with, certainly, the customer base in a scheduling effort, how can we take incremental steps to improve velocity. We do need the rail system to go acquire flatcars so that they can accommodate volume from the new containers that are coming on board, whether that's ours or others in the industry. And I think the industry has taken steps in order to do that. So do I think 2022 can have velocity improvements? I guess, I would certainly hope so. But in the event that it doesn't, I do think that we are positioned to grow even without velocity improvements in a material way. I mean 12,000 containers is a big number. And certainly, we are confident in our ability to put those containers to work.

Got it. That's really helpful. Maybe last question on Intermodal before we turn to some of the other segments. Just on the margin side, you guys have done a really good job of protecting your margin despite all these issues, despite the congestion you're seeing out there. How do we think about the near-term trajectory for the back half of this year and going into '22? Clearly, the accessorials should help with the margin somewhat, but then you're bringing on some more resource as well. So how do we think about near-term margins in the context of your long-term guidance?

I think earlier this year, we talked about a long-term goal of 10 to 12. We felt confident in our ability to hit that range during the calendar year. And we continue to be very confident in our ability to do that. I don't -- the costs that are headwinds to us have been material. Yes, pricing is up because those costs are up and those costs are up for everyone, and that's what's driving a lot of that result. But I wouldn't anticipate anything beyond that long-term guidance that we gave earlier this year.

Got it. That's helpful. Maybe switching to Dedicated, which is the other kind of big growth segment for you guys. It seems like Dedicated is one of the fastest-growing parts of the entire transportation complex you guys had. I'd say, bad news is good news in the second quarter and that it was -- relative to expectations, slightly a soft quarter, but that was driven by a lot of launch costs because you had several new programs launching. Can you just talk about, again, for the back half of this year and going into '22, what does the pipeline of new business look like? When do those new launches mature and then really kind of translates into margins pushing the high end of your long-term range? And what does all the fleet count look like in Dedicated?

Ravi, it's Brad. I'll take that. So as we've been communicating, the backlog and the pipeline is as robust as we've probably ever seen it. As you're aware, we normally talk about targeting gross truck sales of $800 to $1,000 per year, and I think we were north of 1,200 through the first 6 months of this year. One of the things I've talked with investors about is, if you go back to last year, we really did have some strong sales towards the back half, but it wasn't as highly correlated with the truck adds that you saw and some of that is a function of us effectively bringing down some of our idled equipment. So we've essentially exhausted our idled equipment. So I do believe there will be a tighter correlation between some of those sales numbers we've talked about and what you would see kind of come through in the pipeline or as we report. So we added 555 trucks in the second quarter alone. We're not going to provide an update or comment on where we are, but the backlog continues to be very strong. We are bringing on a bunch of new business. I think Darren alluded to, the driver market is extremely challenging. But we do feel like we have some advantages. We have a very strong department that does nothing but recruit drivers for us and we'll see how that plays out. You're right. Bad news is good news. I think of it as good news is good news. When you have a 98% retention rate on that business, and we've consistently talked about, hey, when we bring on new business, there's going to be costs associated with that. We're incurring costs before we recognize revenue. And so when we are adding trucks, yes, it may be dilutive to margins percent in the near term. Hey, when fuel prices are higher, it's dilutive to margin percent. It's why I've spent so much time focusing or trying to focus folks away from margin percent and thinking about how we think about Intermodal and how we think about all of our businesses, which is returns on capital. But I think you're going to continue to see a lot of truck adds. I think that will put pressure on margins in the near term. But I think that creates a whole lot of momentum going into 2022.

Got it. I have a bunch of audience questions for you here, and please keep sending more in. Before I turn to that though, one question ICS. Any updates there? I mean clearly, the gross revenue line continues to grow gangbusters. You guys have done a really good job of bringing that business back into the black quicker than you initially thought it would. Is that now a permanent black number? How do we think about pushing those margins up towards more like mid-single digits?

Yes. There's no official update, but I do -- I'll just reference back to what we've been communicating. We expected originally to return to consistent profitability in the back half of 2021. Really, that was based upon the investments in people, technology, as well as scaling the platform. This environment really has provided us an opportunity to scale a whole lot faster than we expected to. And we did kind of cross that profitability threshold a lot earlier than what we thought. I will say we continue to be ahead of schedule on many fronts, whether it be profitability, whether it be size, scale, whether it be productivity. And that's been good for us relative to the 5-year plan we laid out a few -- 18, 24 months ago. So nothing is guaranteed, but I would say we continue to hope to make some progress. We do have some additional productivity measures that we think will help us get additional leverage from our investments in technology. Hopefully, we continue to see those come through over the next several quarters. But I would say at this point, I'm comfortable that we're going to stick with what we've originally said, which is to be consistently profitable by the second half of 2021.

Got it. So Brad, when I think about that business kind of longer term, is the right way to think about it that you guys will continue to scale up the business and try to capitalize on economies of scale while holding the profitability at current levels? Or are you looking to, at some point, kind of say, hey, we've hit the right size. Now let's take the margin up. And how do you think about that balance between top line and bottom line?

Well, I think your willingness and your pace of growth that you're targeting will impact profitability. I do think profitability and earning an appropriate return on our investments is an important part of our DNA. And so I would think that, yes, we will be making decisions about how to balance the 2. When I think about growth in ICS or scale, I don't know that we've really -- in terms of our messaging, I don't think we've scratched the surface yet. So I think we still see a long runway of opportunity to grow and scale that business. And in doing so, the whole goal and vision is we should be growing gross profit dollars disproportionately to our operating cost, and that's the leverage you get with some of the technology investments that we're making. And we'll see how that plays out. I think we've seen early signs of how that gross profit dollar number has changed, whether sequentially or year-over-year relative to our operating cost. And if that trend continues, you can see how margins begin to expand because the flow-through of those gross profit dollars to the bottom line become more meaningful.

Got it. So maybe we can go through the audience questions here. Are you using more third-party dray to deal with congestion in IM, I assume?

Yes. I think that the -- we have been able to expand our drayage resources in-house. So that's from company drivers where we are larger than we were at this time last year. We do utilize outsourced dray. I think that as a percentage of our business, it's similar to actually slightly down this year. So it's always been a key part of our strategy, particularly in the fall peak season. You have to dip into the outsource community, and we will continue to do that, but there's not a real step change going on for us related to the amount of outsource we utilize.

Got it. Is there any situation where J.B. Hunt is responsible for paying rail accessorials like empty containers, et cetera?

Is there any scenario where we are responsible for paying?

Rail accessorials, yes.

Certainly, we don't comment on our rail contracts. And so probably -- but it would make sense that if we ask the railroad to perform work that there is a mechanism that we compensate them for that work.

Got it. Next one is how many net additional containers can you bring on in the second half of this year? When does container supply ease?

So we talked about in our second quarter earnings call that we would have between 3,000 and 4,000 during the third quarter. We still feel like we will hit that range. And with the 12,000, we had said early on that it was our plan to get them all here this year. As the year has gone on, we have said we think we'll get the majority here. We'll probably have a more thorough update on that in the third quarter earnings call between now and then. I probably can't comment on that. Do I know when it's going to ease? I guess that is such a -- that's that same crystal ball around 2022. And when will fluidity of ocean transportation improve, I have no line of sight to that easing through the end of this year and certainly into the first quarter, at least. I'm probably unwilling to go beyond that just because I would be flat guessing.

Got it. There's been some STB commentary on rail pricing. Kind of how do you -- and kind of one of the railroads yesterday said that they were concerned about the regulatory environment. How would you -- what are your thoughts there?

No. I think that the STB and the activity that they're engaged with the railroads is an area that we have long just kind of stayed out of. That's not an area that -- certainly, if the STB implements programs that influence the way our rail providers function, we're going to pay very close attention to that. I find it -- at the end of the day, the railroads are asking everybody to clear their terminals so they can do more. They don't want to get storage dollars. They don't want that money. They want the container to exit the terminal. And so it's an odd scenario to where, by them imposing charges to incent that, they seem to be under pressure to stop doing that, and this doesn't translate to me because slowing down charging for detention at -- or dwell at their facilities is only going to make the terminal congestion get worse, not better. So I guess I would ask the regulators, what is it about regulation that would actually improve velocity. Now if their regulatory efforts are saying maybe that the chase to a sub-50s [ OR ] needs to be more balanced with investment for growth, that's probably a worthwhile discussion.

Got it. That is -- that's a very helpful thought. We are out of time in our 30-minute session. So Darren, John, Brad, thanks so much for joining us today. Fascinating discussion. And yes, let's hope the world is a little more normal in 3 months' time. We'll see.

Sure. Thanks, Ravi.

Thank you.

Thank you. And this does conclude the presentation.