Ryder System, Inc. (R) Earnings Call Transcript & Summary

Good morning. This is Jordan Alliger, and I'm pleased to kick off the transportation logistics portion of the Goldman Industrial Conference with Ryder's EVP and CFO, John Diez. We look forward to hearing about Ryder's ongoing plan execution that sets the company up well for long-term growth and in particular, opportunities in its high-return supply chain dedicated solutions business. Before we get into the Q&A, however, I believe John has some opening remarks.

Yes. Good morning. Let me give you a little bit of background on Ryder. Ryder is a $12 billion company that serves the outsourced logistics and transportation market. We're a B2B company, so we serve small and medium and large businesses alike. We're organized around 3 business segments. Our Fleet Management business provides truck leasing and rental in the U.S. and Canada. Our dedicated business, and that's supporting about 250,000 commercial vehicles in the U.S. and Canada. Our dedicated business, which is not only the outsourcing of the equipment, but the equipment and the driver. We provide transportation services for a number of customers. That accounts about 15% of the business, and that's the smallest of the 3 segments. And then our Supply Chain business, which provides broad-based Supply Chain Solutions to businesses. And if you think about distribution and warehouses, today, we operate about 95 million square feet, about 300 distribution centers in Mexico, Canada and the U.S. We've made a few purchases in the Supply Chain businesses, acquisitions that have expanded our capabilities. We like to think of ourselves as a port-to-door solution now. We just purchased a company called Whiplash, which provides e-commerce solutions for the U.S. market, so we could deliver directly to people's homes as well as to storefronts as well. The company, the last 3 years has been through a transformation phase. Three years ago, we established our balanced growth strategy. There's 3 anchor tenants to our balanced growth strategy. One was to de-risk the model. And if you think about our Fleet Management business, we're looking to really reduce the dependency on residual values on the backside of a lease to get the return. So we reduced the pricing -- the price residual values, which actually lifted pricing to the end customer. We've also been focused on improving returns and cash flow profile of the business. And in that area, we've gone through a multiyear maintenance cost reduction initiative where we've been able to hit our target of $100 million of annual maintenance cost savings from 4 years ago. We reached that target last year. We've also been able to increase the spread and the pricing profile of the lease portfolio. And right now, we're about 65% through that. We think that's going to deliver, at full scale, $125 million of incremental profitability for the business. We have also looked to the third component of our balanced growth strategy is to accelerate the growth in our higher returns business. So that's the Supply Chain and Dedicated business, which are asset light. And we've been acquiring businesses as well as growing those businesses organically. Supply Chain last year grew about 45%, half of that came from organic growth, and then the other half came from acquisitions. So over the last couple of years, if you look at our revenue profile for the business, Supply Chain and Dedicated in 2018 used to be about 37% of the business. Today, it's 54% of the business. So lots of changes in the business. We've changed the business model to make it a more resilient and a business that's going to perform through the cycle. And then last year, we had a record level of performance, both on the revenue side as well as on the bottom line. We had a record year for EPS, $16.37. Our previous high was $5.95 of EPS. So significant changes in the business model, which are playing out and performing quite well today.

Great. Well, thanks for that intro. And maybe kicking it off with a bigger picture question, you mentioned optimizing or maximizing returns over a cycle and free cash flow. Can you maybe talk a little bit more on what that means? Like what are you -- how do you -- how are you thinking about returns? And do you mean that free cash flow will be less cyclical than prior cycles?

Yes. So the way we had the business set up, we were looking to grow our Fleet Management business. That's a business that's very capital intensive. And as you grow that business, it actually -- you need to draw on cash flow, and it became a negative free cash flow story for us for a number of years. We've moderated the growth in that business. And as a result, we expect that the overall business will perform with positive free cash flow in most years and then certainly positive free cash flow over the cycle. So if you look at that profile, cash flow profile, much different from a returns perspective. Jordan, if you look at the business 5, 6 years ago, even during the best of times, it would perform at a return on equity of mid-teens. Today, we're targeting that in the bottom of the cycle, it's going to deliver mid-teens. And then over the cycle, it should deliver high-teens performance, and that's reflective of the actions that I mentioned earlier.

Got it. Maybe thinking a little bit more near term, FMS obviously has had great margins of late. Some of that has been helped with the used truck markets. So how do you think about the balance of this cycle, margin stability against the used trucks? Maybe some color on that.

Yes. So if you think about our Fleet Management business, we've given that target out there of low double digits. The business the last couple of years has been approaching 20% of EBT as a percent of operating revenue. We think that's going to normalize, right? Last year, we did about $400 million of vehicle gains. That number will come down. And we expect that business now in the softer freight environment will deliver more of the low double-digit performance. So the business is still performing better than ever with regards to those metrics. But we do expect gains on used vehicles to continue to decline as we get through the 2023 year.

Okay. And on the lease business, choice of lease, let's say, obviously, the freight markets have been slow broadly. I mean we've seen that in a lot of tonnage numbers that have come out this earnings season. Has there been much impact on the demand for your longer-term lease services?

Right now, we've got about a 9- to 11-month backlog on our leases. So most of the fleets that we're going to be introducing over the next year have already been signed up for. So I think if you look longer term beyond the next year, we do expect some softness. I think we're seeing customers take a little bit longer in this environment to make decisions. They may not be as confident in their business conditions to sign up for longer-term leases. So that may be something that will impact us when you look at 2024 and into 2025. But nevertheless, we're still seeing good activity in the marketplace, and we do expect the business to continue to grow despite those headwinds.

But renewals of existing business, you'd say those generally track.

Those are steady.

Right.

The renewals have been steady. We've got a good portfolio of customers. I think where we see the biggest risk on renewals is in the transport space. We serve that market. And we have seen a number of bankruptcies amongst the transports, the over-the-road carriers. That's not as big a component of the portfolio of what it used to be. We've intentionally made that smaller. So we will see some pressure there in the tractor space, but broad-based, we're seeing good renewal activity across the board.

Okay. And then you mentioned the repricing, which has been an ongoing strategy. Is that tougher to do in this environment or not really?

What we saw early on was everyone's feeling the inflationary pressures. Early on in the cycle, we also saw where labor shortages were impacting. Those that wanted to own their own fleets or wanted to provide their own maintenance, and that made it even more challenging. So we continue to see a propensity for folks to really outsource and not be in the maintenance game. And with that, we're still able to bring compelling value to our customers. So we have not seen, from a pricing point of view, a significant change in that climate. We do expect, though, as economic conditions continuing to get softer, you may see where decisions are going to be more price sensitive than what maybe we've seen over the last 3 to 4 years. But again, 65% of the portfolio has been repriced. We got another 20% that's been already contracted for. So the majority of the portfolio now has been repriced at higher returns.

And is the competition generally pricing well, would you say?

Yes. I think we still compete in the local markets with various local competitors. And then on a national level, there's one other large competitor. And we compete head-to-head, and we're not seeing anything changing there.

Okay. And when you think about the economy, just because everyone is trying to find the inflection or the bottom, is it the commercial rental that you would get the best sense for what's going on in the economy today and when things may be bottoming? And maybe talk a little bit about that part of the business.

So we have 2 businesses that are transactional in nature, one of which is the commercial rental business, the others on the used vehicle side, and I'll speak to both. The commercial rental business supports 50,000 businesses in the U.S. and Canada. So we've got a pretty good view of what's happening in the broader economic environment. That's kind of the canary in the coal mine for us. Typically, when we see softness there, then we continue to see a continuing degradation in other parts. And what we saw there last year was the housing market clearly started impacting our housing sector to some degree. But even as we got through the end of last year, it was quite strong. We saw record levels of utilization for commercial rental fleet. As we stepped into the first quarter, we did see more of our seasonal drop-off that you see from Q4 to Q1. And we expect that to continue. We are seeing softness in the freight side. So those looking for tractors, heavy Class 8 vehicles, that market has softened a bit. But on the consumer staples, you're still seeing good demand. We do expect freight conditions to soften as we get deeper into the year as well.

Okay. And you had mentioned sort of slowing growth in FMS over time. So what does that mean for your fleet plans, like as you think about it longer term? Trucks per year? However you look at it.

Yes. So what we look at is the growth in our overall fleet, especially our lease fleet, which is the majority of it. We're targeting about 2,000-to-4,000 unit growth a year. This year, we expect the fleet to grow about 5,000-to-6,000 units. So it's heavier growth than normal, and that's a function of, one, the OEMs have had a tough time producing vehicles, and they're just catching up. So we're starting to see some of the growth that we had signed up a year ago come through. And then we do expect this year, we're going to be able to transition some of the rental equipment moving into lease applications and get customers into vehicles faster than putting them in new equipment, which they're going to have to wait 9 to 11 months. So typically, what we would expect is more in that 2,000-to-4,000 unit growth, we're going to outperform this year. Next year, it's still early to tell, but we do expect that to be kind of the more normalized growth rate for us. To put it in perspective, back in '18 and '19, we were growing at 8,000 to 10,000 units, which was significant, which also created headwinds from a free cash flow perspective.

And before we move on to the other business segments, just on the used markets -- well, I guess used and new, I guess, is it -- are you getting your equipment easier, the ones that -- your new equipment? And does -- if the industry itself is seeing a better flow of new trucks being delivered, does that impact the used truck markets and the inventory levels that you're seeing in that?

Yes. So as the OEMs produce more trucks, that creates more used truck inventory because the replacement cycle gets accelerated. We have seen where the Class 8, the heavy-duty tractors, that flow is starting to pick up. And you are seeing, on the used vehicle side, tractor prices come down as more inventory gets introduced to the market. On the truck side, the straight truck side and even trailers, you're still seeing significant tight capacity, and that is -- continues to be strained. So we haven't seen the same levels of decline on the used vehicle side for truck pricing. They're still elevated relative to historic levels, whereas the tractor pricing on used vehicles is starting to approach historical levels, and that's what we forecasted and guided to for the balance of the year.

Okay. Great. Maybe flipping over to Supply Chain, which I think is a pretty interesting part of the long-term story here. Before we talk about margins and things like that, I think one of the things people are kind of intrigued about broadly these days is the near-shoring or re-shoring opportunities in Mexico. With your warehouse capacity, I suspect that sort of potentially plays into your hands. So I guess, maybe give some of your thoughts around that and what it can mean for Ryder. And then how long will it take to start seeing the benefits of what could be an industrial renaissance here?

Yes. So we're really excited about the opportunities that exist today. We are seeing more and more companies looking at their supply chains and whether they're sourcing product or manufacturing from Asia and looking at Mexico as being a potential downstream for them. We've been in Mexico serving U.S. manufacturers for the last 30 years. We have a great portfolio there serving Fortune 500 companies. We do both transportation and cross-border activity to get their goods from Mexico into the U.S. market. And we also do warehousing in Mexico to support U.S. consumption. That business has been a growing business for us for the last 20 years. It's about $250 million in revenue, $260 million in revenue relative to the $3 billion plus in supply chain today. But that's one that we think is going to continue to accelerate the growth trajectory and can provide long-term value. The question that was asked around what are we seeing in the marketplace, up until now, we've been getting a lot of inquiries. I think those inquiries are now becoming more real, companies that are making decisions around where to set up their next manufacturing facility. These are large investments, usually take a little bit of time. I think we're hearing more and more, especially on the industrial manufacturing side of the space that we serve that they're looking at setting up shop in Mexico, and they're going to -- the next plant they open will be in Mexico and closer to the consumer here in the U.S. So we are starting to see that. The industrial and the manufacturing side is where we're seeing most of the activity there.

We've heard maybe some of it could be more like this higher-value manufacturing like batteries and things like that. I mean would that be some of the early impression you're getting?

I think that's some of it, but I think it's even broader than that. We are just seeing more and more folks are looking at manufacturing closer to home. And with our capabilities, certainly, we could support those efforts for many companies, which we do that today, both in the automotive as well as in the industrial sector.

Got it. Okay. And I think recently, you sort of reorganized some of your verticals. I don't know if that's the right word for it.

Yes.