Schneider National, Inc. (SNDR) Earnings Call Transcript & Summary

My name is Garrett Holland, Senior Analyst covering transportation, logistics at Baird. Pleased to have you, and we're pleased to have Schneider National participate in the conference this year. From the company, we have Steve Bruffett, Executive Vice President, Treasurer, Chief Financial Officer. [indiscernible] going be all Q&A format. We look forward to the audience participation. If you have a question, just feel free to raise your hand or go ahead and submit through the portal, and we'll take those as they come up. So Steve, thanks for being here. Maybe just to start broad and level set for the audience. Talk about the changes at net over the past 5 years, a lot of focus is on potential downturn ahead. Talk about the structural changes that have positioned the company to better weather inevitable downturn.

Sure. First, thanks for the invitation. Glad to be here, and good to see everyone this afternoon. Thanks for hanging in with us as we get later in the day here. But to address the question here about some of you may or may not be as familiar with us as others, but we have 3 primary operating segments, predominantly known for our Truckload segment, but we have a large intermodal operation as well as a large brokerage operation. So you put the 3 of those together, and it really makes up the bulk of our enterprise predominantly focused on the full container load space. And so -- but if you look over the course of time, we've been predominantly constructed with our truckload operations being most of our revenue and earnings stream. And if you rewind the clock 5 years ago or so when we first did our IPO, we probably generated 70% of our earnings from our Truckload segment. And within the Truckload segment, probably 70% of that came from our one-way network. And so if you do that math, it's roughly half of our earnings came from that source our one-way network in the Truckload segment. And if you fast forward to today, with a combination of the growth that we've experienced across other parts of our business, including our dedicated operations within the Truckload segment. That one-way network probably comprises 25% or so of our earnings stream. And it's not like we're trying to get out of that business or don't like it. We do. It's just we think we found the right size and role within our network of that truckload business. The reason I'm talking about it that way is because it tends to be the most cyclical earnings stream within everything we do. And so the fact that it's a smaller percentage of our total is part of the message I'm trying to convey here. That, coupled with our dedicated operations now comprises about 60% of our truck count within our truckload operations, and that's a much more consistent. It's multiyear contracts. And just a different way of operating. So there's less cyclicality involved with that part of our operations. And we've been able to steadily grow intermodal and logistics throughout cycles. And so that growth element within there helps to offset otherwise what would be cyclicality. And so we think that our construction by itself lends itself to a much more durable and predictable earnings stream as we go through time. And we think we have a pretty exciting growth story for being -- especially for being at scale already that we still have plenty of growth opportunities ahead out.

That's great and helpful. As we think about 2023, help us understand the financial planning and buzzing approach at Schneider, how do you build flexibility into the plan for a range of outcomes?

Yes, you want to work on our budget right now, tell us what look like -- we're actually in the process of putting that together. So I guess I'd separate an annual budget process from an ongoing planning process that this rolls through the year that we use to steer the business that we do an annual budget that has some performance and compensation elements tied to it, but it doesn't necessarily help us steer the business. It just set some guideposts for us. And so -- but we do go through scenario analysis and think about what's the year going to look like. Ultimately, we've got to land on one set of numbers across our businesses. And so people know where that bogey is. And as we're constructing that thought process as we sit here today, I rewind the clock to a year ago at this time when we were putting the 2022 budget together. We're not always this good, but we happen to be pretty good at this one because we anticipated that the first half of the year would continue to be a really robust market, and we can have some visibility as to how we were going to roll into 2022. And then we expected a moderation in market conditions as things settle back into a bit more normalcy. And that has played out that way. So I'd say we're tracking pretty long with our budget. What would be that good in 2023? I don't know. But as we're thinking of it, it may be a little bit of the flip of how we approached 2022. There has been I call it moderation just a sense of normalcy and as we've gone through the second half of the year. And as we sit here today, volumes are steady, sideways where we don't really see a lot of variation at end of week or end of month like you would expect in normal years, it's just a fairly steady pull-through our network businesses. At the same time, we're still seeing some modest growth in our dedicated operations even in this environment as we stand up recent wins. So we feel good about all of that. And I think -- so as we enter 2023, probably would be more of the same of that with some seasonality built in there. And then I think we'll start to see some wind in the sales across the space as we get into the second half of next year. And it's how we're thinking about it.

No, that's helpful. And covered a question on our house peak trending. Does it feel like just a normalization demand or just the start of something worse?

I think there's a lot of shipper-by-shipper stories to be told out there. And there are some large shippers that have dealt with some larger inventory issues and supply chain issues and it's created variability and different behaviors from people, especially if they have international supply chains, they've tried to get a lot longer lead times involved, and it's led to things getting in and sitting in places longer than normal and moving those things around it. So there's just different dynamics that people are working through. I think if you're one of those companies, you're probably really motivated to deal with that stuff this year to the extent you can and not carry that story into 2023. So there are some like I said, some company-specific things, but when you average it all out into our business volumes, it tends to just beat it's like "Here's your tenders, and we're accepting the vast majority of what we get tendered today," whereas a year ago, we could only accept half of them because there was always disruption in the market. It's just that leaves settled in and it's more of a steady. I don't -- to answer the second part of your question to us, there could be an air pocket or a soft spot, I would expect a seasonal soft spot starting in the second half of December and maybe carrying through the first half of January or so. Not out of the ordinary, but probably a soft spot. But then I think by the time, especially if we get into the March time frame, that will be pull some of the slack out of the rope and things will be pretty decent once we get beyond there.

That's helpful. On an intermediate-term basis, perhaps the demand for dedicated service has been great, strong growth driver for the truckload business. What does that pipeline look like? And what do you think a sustainable growth rate is over the longer term for dedicated operations?

Yes, it has been a great pipeline, just the pipeline. Fortunately, things are moving through it and we're landing wins and experiencing growth there and would anticipate that we've got a lot of opportunities in the pipe right now and think that we'll continue to see that. We think we have a good value proposition, and we're not trying to be all things to all people in the dedicated space. We're trying to truly bring a value-added service and proposition and do something beyond just get freight from point A to point B for a customer, be that specialized equipment or a driver doing something special for the customer that's not that easily replicated. So feel good about an ongoing pipeline. We may have seen a bit of elongated decision-making start to emerge a little bit or waiting until next year to make a decision. It might be a nuance that we've seen, but still there's been so much in the pipeline that we're still standing up a good number of opportunities as we head into 2023. And as far as what we're targeting growth, we don't -- of course, we want as much growth as we can, but there's also a practical reality as to how many you can effectively stand up at a given point in time because you want that customer experience to be good from day 1. So we think in terms of several hundred trucks a year of net growth in the dedicated space is a reasonable expectation that we'll continue to pursue.

And maybe turning to the pricing outlook. A lot of focus on where contract pricing is headed next year. You've got some interesting tension between inflationary pressure as well as shippers looking to stretch transportation budgets a bit further. Take us into those pricing conversations. How do you see that on full being, some unique tension on both ends there?

Yes, it goes back to where we started with budgeting conversations. How do we think about especially the contractual nature of our business that renews on an annual basis and what that setup looks like? And we do expect that there will be ongoing cost inflation in 2023, albeit at a lower rate. Most of what we would experience in 2023, we're anticipating would [ dispelled ] or effect of what's already happened and less upward pressure as we get into, not that it goes away, but maybe more historical types of increases on a per unit basis that are unique to 2023. But then if you get into the price discussion, there's the reality of those costs. And it's not unique to Schneider by any sense of the imagination. So there's a practical limitation, I think, to where those price discussions can go. At the same time, there's opportunities for us to talk to our customers about, okay, we can get you to a place you want to be if you can work with us on lane configurations or types of rate or this or that within your operations that help us operate more efficiently. We're certainly glad to have those conversations.

And the small carriers is clearly feeling a lot of that pressure. What are the indications that you're seeing of capacity exiting the market? Ultimately, that helps restore balance pricing bottoms on the spot market side and we reboot the cycle all over. What are you seeing on the capacity side on the exiting front?

Yes, we're seeing some evidence. I wouldn't call it overwhelming evidence of exiting a small carrier capacity. At the same time, this isn't really the time of year where you we would, from our experience, expect to see that. I think if you're in the space, you're probably going to try to top it out through the holiday season and then see where things -- what it feels like to you once you get to year-end and if you want to pick up the keys and get in the seat once the next year starts or if you want to look for something else to do, I think that will be a [ litmus test ] in this particular cycle to see if there's a greater [ test to this ]. And the way we look at it being predominantly a contractual carrier, be it an operator, whether it's intermodal or in the truck space. either capacity exits quickly, and that supports spot price, and that's good for the contractual space or for the spot price moves up, and that's good. So we see it. And like I said, I'm not trying to paint 2023 as just a gold opportunity, but I don't see it as a dire situation either. I think there's inherent tensions but a settling in at the same time, over the last couple of years, especially in our network businesses for a variety of reasons, they have not been efficient operations by any stretch of the imagination. Some due to us, but some due to our customers and their labor issues and their supply, their inventory issues in the rail space, some of their labor issues and service issues, it's the fluidity has not been there. The productivity and efficiency hasn't been there. So we have an opportunity, I think, as some of those things become more fluid to help self-help, if you will, through -- across the space and help our margin profile that helps with some of the probably inherent pricing pressure that will come with 2023.

That's great. And turning to the capital investment plan for next year. The OEM order book certainly will be wide open. Are you thinking about replacing equipment for next year? We'll see remains to be seen if they can deliver all of these trucks. But how do you help us make some sense on what's going on with the Class 8 [ movers ]?

Yes. I actually think from our observations that there will be still ongoing constraints with the OEMs. So it may be a little less than what we experienced in 2022. But from where we sit, we don't see a wide open. They may want to take as many orders but their ability to deliver units, I think this incremental capacity over 2022, not wide open. And that is a unique element that's probably and a way of looking at it helps the broader transportation space as we've gone through this particular cycle is that there has been constraints and not everyone who wants a truck can get a truck. And so I think that, that can help with the downside or the other side of this equation, that things didn't get up to here so quickly that there's not as far a drop.

That's great. Maybe turning to the less asset-intensive part of the business. Some exciting things going on with the intermodal operations. Help us understand the line of sight you have to recovering rail service, long-awaited as well as an update on the transition to Union Pacific out West?

Yes. That second part, we're certainly excited about and getting within weeks here now being able to actually have our game day and do the live conversion from our Western partner to the UP. And so we're looking forward to that and have put a ton of planning into that as the UP. And so that partnership has been great and the investment on both sides has been harnessed and on track. So we feel good about all the planning and preparation for that. We currently have about 20% of our non-competing lanes moving on the UP. So it's 80% of the volume to transition once we get to January 1st. So it's a big task and it won't happen in 1 day or 1 week. That's a lot of containers and chassis that move around and drivers to get repositioned and so on. But we've got a great team in place and a great project plan to execute that. And I think that both parties are -- all parties involved or have a vested interest in making sure that, that goes well. We're excited about that. And to the first part of your question about rail fluidity, I think that we're -- we'll start to see some signs of that freeing up as we move into 2023, especially once we get into, say, the March or April time frame, I think the labor issues that the constraints and everything that they've been dealing with, which have led to erratic service and so on will start to free up once they get a little further down the line with their initiatives. So I think that will certainly help. And so we feel like despite a potentially softer environment, particularly in the first part of 2023, we think we have some structural tailwinds in intermodal that will contribute to our success in 2023.

And specifically, there is a margin drag in the third quarter as you prepare to make that transition. How quickly does that headwind go away as we turn the calendar? And then help us understand the economics of the move in UP. Is it better? How is it better for Schneider? And I know you're excited about the longer-term growth opportunity as well.

Yes. We are excited about that. And you are right, we did have some duplicate costs in the third quarter, and we anticipate those continuing in the fourth, as you would imagine. But I think we'll be able to shed them pretty quickly in the context of January. It would be my expectation given the project plan and the need to execute that quickly and efficiently. So it's time-bound. And then I think that the opportunity set for us, I'll say it this way. We've laid out our long-term margin targets for the intermodal space being 10% to 14%. And I don't really see us moving those goalposts as a result of the move to the UP, their strong margins, good return on capital profile. For us, it's about a growth opportunity and a distinction opportunity that we're excited about. And I think that we will add to our earnings dollars by maintaining those solid margins and growing volume and revenue and earnings dollars by doing that.

That's helpful. Turning to logistics. The business has grown dramatically this cycle. Help us understand a more normalized growth rate for this business. You continue to invest there, but we'll stack up against some tough comparisons. What's the long-term growth rate for the logistics business?

Well, I think for the foreseeable future, we're talking double-digit volume growth. And I say it that way because with roughly half of the business we do in our traditional brokerage business is in the spot market, the other half is contractual. So you can -- get your top-line revenue can move all over the place, but your transportation costs are moving all over the place at the same time. So if you think through that noise and think about net revenue that I think would -- that's where we would expect to see double-digit percentage growth organically. As fuel these days by our power-only offering, which we report in our Logistics segment, and it's part of those operations, and we see some sustainable growth opportunities within that offering as well, which is using our Orange trailer operating out of trailer pools and making that freight available to third-party capacity and the contractual nature and the stickiness of that business and the opportunity for us to say yes to more customer opportunities and fulfill it through that third-party capacity, I think, is an exciting opportunity that will help fuel the growth of that logistics segment.

One of the drivers of this growth is clearly the power-only offering and something unique to the asset-based carriers. Is it too early to see how sticky that business is with some of the cracks in demand? How -- have you seen any change in the demand for power-only services? And what are your expectations for power-only performance through the cycle?

Yes. The changes we've seen, I think, have been symmetrical to what we've seen with the rest of our network business, if you will. So I wouldn't characterize it as being different than that because it's really an extension of that. And if it was a pure spot market or overflow play, I would answer it differently, but I see the way customers embrace the solution and the ease that we bring to the market with it to the customer, there's no difference. And whether it moves through a company driver and owner-operator or third-party capacity to the customer, it looks the same. It's our box, it's our process, it's our stack. And so it's a seamless process for them. And we navigate how to best move to load.

No, that's helpful. Interesting to hear your perspective on how technology has facilitated some of this growth at logistics. What opportunity is there for tech investments to further automate at logistics? And what does it mean for the margin outlook?

Yes. I guess there's always opportunity for further automation, but we've made a lot of headway. We have a lot of the tools and technology in place today for automation and a lot of our moves. And in fact, these power-only moves are very low-touch, if not no-touch types of transactions. And so I think the opportunity set of while we can still invest in technology and ultimately, we'd love to have a seamless appointment setting and all that type of thing without a human touch. We haven't gotten there yet, but it's always on the radar screen that something we'd like to accomplish. But -- it's really just through continued growth in a lot of the tools. We have our platform, we label Schneider Freight Power and it's a digital way of connecting with third-party capacity and with generally speaking, the smaller shipper and connecting those. And we think that is a pretty deep pond that we can continue to fish in. And as that becomes a bigger percentage of our overall logistics business, than just inherently, you end up with greater automation inherent in your business.

Longer term, there's a lot of optimism for more near-shoring activity. Clearly, you've got intermodal operations, nice cross-border business as well. Are you seeing more of that trend? Help us understand the timing and potential benefits from nearshore.

I think that's something that happens over decades or lots of years, and perhaps this pandemic experience will accelerate some of that, but still plant capacity and all that, the types of things that don't happen quickly. So I can't say that we've seen tons. What we have seen is this maybe a different definition of reshoring. But because of constraints in the Southern California ports, we've seen fluidity in what ports freight are arriving in. And so our dray capabilities on both coasts and have been proven to be quite useful and valuable to customers as we've worked through all of this. And so I think that will be the near-term interesting story to see what ports East Coast, West Coast, up and down, do freight volumes settle into container moves. And that's something that we're well positioned regardless. Longer term, we love the -- we're well positioned and already have a robust business north-south, including Mexico and look for further growth look as we move ahead into that. That will take some time. We have some near-term opportunities, but for there to be a big shift in that, I think it will take some time.

And on M&A, after trying to be opportunistic there. What are the priorities as you see them for M&A? Where would you like to add potentially as we move through this downturn? Are you seeing more conversations having those and more deals cross?

Yes. We're actively looking and have several opportunities that we're evaluating. It's a big, wide funnel at the top and a little skinny at the bottom is what makes it through. But generally speaking, we've been looking for medium-sized opportunities, not swinging for the fences type thing, the complementary acquisitions that add to our dedicated and/or specialty operations that bring with it that inherent durability and repeatability, and driver preference along with those operations. If you look across our portfolio, we're probably going to stay within what we do well, which is predominantly focused on the full load market or not likely to venture outside of that. But within that, there's not a lot of activity for us to pursue within the intermodal space. Logistics, we're growing organically at a nice clip and like the opportunity set in front of us. So when you look across that, we see the best opportunities for us, at least as being within those specialty and dedicated markets.

Great. Maybe to circle back where we started the conversation, this cycle, you've demonstrated much higher highs as it relates to profitability. The outlook has potentially changed. I would expect higher lows as well. What's the right framework to think about trough earnings power? You've got stated margin targets by segment. You defend those in a recession. Just help us understand the right way to think about it.

Yes. Going back to where we started, I think with just the shifts in the portfolio construction themselves lend to a higher low, if you will, or less downside to our earnings stream. Even if you compare '18 into '19 and what that looked like at top of mind, I think we were down something like 20% there. No 2 downturns look like and upturns look different. So it's hard to just directly compare one thing to the other. But cutting through all that, if you use that as a benchmark, we certainly would expect to perform better than that, all else being equal and be more resilient than that. We haven't dropped a specific number out there or percentage or whatever, but we certainly think that we have opportunities to -- in this upcoming year to operate more efficiently and create some of our own tailwinds and have some organic growth underneath all of that, that helps with that on top of our composition. So you put all those together, we feel pretty good that we've got a strongly resilient business put together here.

That's great. I think it's a good place to stop. We're out of time. Special thanks to Steve and the Schneider team for participating in the conference. And I hope everyone has a great rest of the day. Thank you.

Thanks.