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

Good evening. We're very pleased to have Schneider National Management participate in the conference again this year. From the company, we've got Mark Rourke, President and CEO, James Filter, Executive Vice president, Group President of Transportation and Logistics at Schneider; as well Steve Bindas and Tyler out here as well as new CFO, Darrell Campbell. So thank you for being here. We're going to dive right into Q&A. [Operator Instructions]

Gentlemen, let's start by level setting with structural changes going on at Schneider over the past 3 to 5 years. Obviously, you prepare for a downturn years in advance. Let's talk about those changes and how you think they performed now tested in a downturn?

Garrett, thanks for having us. And maybe just start with that positioning of the business for the long term, through cycles and across our 3 segments of truckload, intermodal and logistics. First, we've been after a multiyear effort to recast our truckload dominance to be more associated with dedicated long-term contracts, specialty services, deep with our customers. And as we came out of the third quarter, a little over 60% of our trucks now are in that configuration. And we do that because of that deep relationship that we get and high renewal rates, and so we can have a very steady stream of revenue and earnings contribution to the business. And quite frankly, our professional drivers prefer that type of work, so you have to have that in the equation as well. And so both through organic growth and through acquisitive growth, so we've been successful. And as I mentioned the last week, we feel really encouraged by the start-ups we have scheduled in the fourth quarter and in the first quarter. We can't see out yet much past the first quarter, but our momentum in that dedicated configuration within truck, we would expect to continue. So feel really good, as well as our acquisitions that we've done, 2 of those in the last couple of years that are very accretive. Secondly, in the intermodal space, we've been recasting our relationships in the rail side to get maximum differentiation competitively with our other large asset -based intermodal provider. And with asset base, I mean, we own and control the box, the chassis and the dray assets across that. We think that creates the best experience for the railroads, which are an important part of our equation, but also certainly the best experience for our customers. And so we now are going to go into our second season. And with -- a year ago, we've been sitting here talking about a transition we were about to go through with the UP, that's been successfully executed. We've added a new anchor relationship with the CPKC as their anchor provider in and out of Mexico, which we think is going to be a huge winner in this trend on nearshoring. So we feel really good about that, not only positioning there, but how they're performing. We're encouraged by Jim's actions at the UP to really get after performance there. And then we already have a really high-performing eastern partner with the CSX. And then as I jumped to our third, our stand-alone brokerage offering, collaborative with our assets, but not beholding to them, they have their own capability to create demand and serve customers, particularly that long tail, small shipper, feel really good about that. But we've given them some extra resources, but it's power only to be able to tie small carriers to large shippers via the trailer pool. And that question of, is that a durable service through our highs and lows, we can sit here now, been through both of those and say, that's a very durable and very shipper-friendly solution, and gives us another opportunity to grow our earnings, without having to put a driver and another piece of capital at play. So all 3 of those are really on pace and exactly what we were after. Obviously, we're challenged in a very distorted market, both on the upside here through the pandemic and now the hangover effect coming through that. But long-term positioning, we're where we want to be.

Yes. That's a great overview. I guess as we think about, the trajectory area of profitability, over the next few quarters, how do things improve? Do you manage the business differently at the trough of the cycle? Obviously, you're committed to this long-term strategy. I think makes a ton of sense. But how are you managing the business through this trough?

Yes. And our resources and drivers and capital are fairly fungible that we can take advantage of where we see the best opportunities. But as we start to go into this new year, we'll probably have less momentum than a year ago, certainly on the price line in our network businesses. And we'll see where the whole season comes out, but demand on a seasonal basis is still a bit muted. But we also won't come into the year with this large inventory hangover that we came into 2023 with. So as replenishment, whenever that starts to get more momentum, we won't be dealing with what we dealt with in 2023. And now that we have a year under our belt, with some of our transitionary elements in intermodal and a more mature power only, and where we are with dedicated, I think we're just positioned to take advantage of the advantages once they start to materialize.

Now that's great. I guess thinking about the peak season, any change in demand as we're now a month into Q4?

Yes. So we characterized it fairly tepid but steady. And I think the big change here is seen some disruption within some of the brokerage companies that are out there, some of them going out of business, creating some disruption. And customers, when they're faced with that situation of a bankruptcy, what we're seeing is that they are moving more towards the assets, creating more opportunities within our assets. And so when we think about what will be going on ahead of us here, customers might not be trying to take that last nickel off the table and a little bit more constructive, understanding of what could be ahead of them. As you start to see the impact of a disruption like Con-way exiting the marketplace.

Yes. No, I would imagine, the market response to incremental disruptions like that, does that give you confidence we're moving closer to equilibrium?

Yes.

Yes. We -- this whole 30 years doing this, going through multiple cycles, it's certainly been stubborn relative to the capacity correction. Historically, Garrett, we were thinking 2 or 3 percentage points of capacity starts -- either direction -- starts to change the equilibrium. I think the overbuild through the pandemic has got that number in the 6% to 8%, which is part of why I think it's taken so much longer to get there. But the things that we look at, the lease turn-ins, the amount of calls coming in from distressed owner operators or company drivers at other firms and our recruiting pipeline is 2 to 3x anything we've ever seen. So there's other leading indicators that would -- at least that we look at that would suggest that we're starting to see the end.

That's great.

And I think our customers see it the same way in terms of the discussions that we're having are constructive, talking more about a partnership, telling you -- now, we're probably closer to the bottom of the cycle, looking for opportunities, trying to minimize potential disruption in future.

You talked about the importance of dedicated, is core to the strategy. It's great to see you still have visibility to growth in the fourth and first quarter. What's driving that? Talk about the pipeline in dedicated and any changes in competitive landscape.

Yes. I'd say our customers have higher and higher expectations for service and their supply chains. And that's just the way that they're building them. And if you want to have 95%, 98% on-time service, within your supply chain, you really need to engineer a dedicated network. You're just not going to be able to do that with a regular network operation. And so really, that's been our focus are those customers that are trying to achieve that type of discipline in their business and solve it with dedicated.

Yes. And secondly, it's been the specialty markets that's been behind our growth, things that take a specialty piece of equipment that maybe we have to help with an OEM manual to engineer design. Those things aren't just going up every 12 months. You're really locked in together to solve whatever they're trying to solve, whether it's taking logs out of a logging field or delivering ATVs to dealers double stacked in a 53-foot van. Whatever that solution thereafter, that's something that's very durable, and we think it best positions our driver capacity and best positions our use of capital .

That's great. What do you think a sustainable growth rate for the dedicated business is?

Yes. My expectation, even if at a 95% renewal rate or higher based upon 7,000 trucks, you're at 350, if you just have 4% or 5% churn a year. But I would still expect on an organic basis, that we're growing 300 to 500 trucks, after any level of churn you would experience. And then we're still leaning in and we're not looking for fixer uppers on the dedicated acquisition front, but really well-run companies in very sustainable markets. I'd like to think every 18 months or so we could add to that organic growth like we have for the last 2 years with outside acquisitive growth.

And staying on that topic of M&A, how do you view that as core to the strategy now? Just bolt-on deals in the niche of dedicated? How have those transactions perform relative to expectations? And you think we could do one a year? Or what's the expectation?

Yes. I would -- first of all, we're very pleased with the performance in the markets that we've gone out after those 2 acquisitions. We're ahead of not only their performance but plus our synergies that we brought on top. We're not trying to paint them completely orange. They have a very unique DNA that made them special to those customer base. So we're just trying to enhance what they do. So feel really good about that. And obviously, our balance sheet gives us flexibility to keep going on a programmatic basis or something more transformative if we can find something that makes sense, consistent with our strategy. So we have a lot of firepower, a lot of flexibility. We've got a very supportive board that -- liking what we're doing there. And so we're in the market, and we're looking at lots of things, but we're also -- want to make sure it's right for us and that we can be successful with it.

No. That's great. Turning to another core piece of the Truckload business, network operations. Help me understand the value you see of that offering longer term, competitive moat around it. Obviously, right now, but what's the growth and then outlook for that business?

Yes. I'll let Jim kind of chime in here. But certainly, our network business, particularly truck is going to have more volatility to it, both on the upside and the downside, has -- it responds most quickly to this whole digitization of the marketplace and quick price discovery. And that goes both directions, right? And we've been through a tough slog of it here in the industry, but there's likely another inflection that goes the other direction. So for that reason and the customer's value, it makes sense for us to stay in that business. But it's probably not going to be where we're going to put our growth capital, and we're going to augment our network business more with our power-only offering and using our orange trailers more so than our having to keep adding owner-operators or company trucks there. But it does help the rest of our portfolio, and it allows us to have unique conversations with customers, so it still has a valuable play, just not a growth play.

And like Mark said, we're fungible with capital, with drivers. So when we're starting up a business, a dedicated opportunity, we're able to jump in there very quickly. We had a startup here in the quarter that was very large and started up in 6 weeks, where others probably would have taken 4 to 6 months to bring in that number of drivers. We're able to do that because you have this large network business behind you.

No, that's interesting. And I wanted to pick up on the point of contract pricing. Are you starting to see more service failures as you work through those bids that seem untenable? I'm just trying to get a better sense of your conviction that we're moving past this pressure on rates.

Yes. I think there's -- we can see it in our book. We have freight that's not compensable to what we need to have long term. We know that we don't -- we believe strongly -- I shouldn't say no. We believe strongly that there's a lot of nondurable pricing out there. And we're seeing it on more frequently, call it mini bids or things that are coming back into the market. And that's certainly a leading sign that people aren't always fulfilling. What might have been a very low price in July may not be working as well in October, right? And we would expect that we're going to see an acceleration of that. And we're going to look for ways to continue to work our book higher and particularly in that network business. And we're doing that as we speak today.

And when we think about the profitability of the overall truckload operation, how quickly can we get back into the targeted band from a margin perspective?

So our bands are meant to be -- I would look at this over a 10-ten year period, 8 of the years we should be within that band. There'll be those times when you might get over it because there's some really market disruption and maybe a year or so that you're below it for the same reason. And our dedicated business and our bulk network business, a lot of those things are outperforming where we need them to be, at least in the range. Now it comes, how do we get to that dry van network business that's under the most stress right now. And so I think we're in the process of rebuilding. And I'd like to think that we'll be on a run rate sometime -- perhaps in 2024, that we will start to get that business back where it needs to be. But we're going to come in to the first part of the year was not the momentum we need.

And on the capital spending side, what's the plan as you start to think about '24? Obviously, I think you've been clear on intermodal, but as you look to the truckload business, what's the need for capital reinvestment?

Yes. We were a little elevated this year because we were behind on some age of fleet objectives because of the allocation from the OEMs for the last couple of years. We made some really good progress on that. We have a little more catch-up to do, but not that it's going to distort our CapEx. And then we're not going to -- as long as we hit our investment hurdles, we're not going to cap dedicated. So -- but that's very opportunistic, and we have to see it before we commit to the capital. So that allows us to have some discipline there. And as we mentioned, we're not looking to add containers or chassis. We got our chassis ratios where we need them to be coming out of here in 2023. So really, it's going to be in that dedicated arena, where we would see any type of growth capital next year, and we're going to sweat our assets in intermodal. And the beauty of growing logistics, we're doing that with other folks capital more so than our own.

Turning to the intermodal business, we saw a nice improvement in volume as we progress through Q3. Talk about the momentum there. What's driving that? is inventory restocking finally here? Are core demand improving? What do you see in the market?

Yes. So a little bit of -- what we've been competing against is primarily over the road and small carriers. And specifically, if you think about Southern California, with the lack of imports that became more of a balanced market. And when a market is balanced, that enables small trucking companies to compete against it, where when it's more of an imbalanced network, it favors intermodal, that opportunity reposition in the market. So there's been -- it was balanced for a long time. It's become a little bit imbalanced here recently and creating some opportunities for the overall domestic market to grow.

Now that's great. A core piece of the intermodal thesis has been you need rail service. You talked about your rail partners. Both -- all really seem to be performing very well. What's your confidence as demand inflects that service quality is going to be durable?

Yes. So I'll jump in here. Well, very high. CSX, when you look at -- when disruptions happen, how quickly they respond, they recover from derailments in a matter of hours or a day. So I feel like they'll be able to absorb that very quickly. CPKC, really impressed with their performance. Transit's faster than truck. Virtually 100% on time, which is almost unheard of. So really excited about that. And then the UP on the last 8 weeks, since Jim Vena has been in there, we've seen a pretty steady improvement in the service levels. But what we experience working directly with them is the action plans that they're building. And they look eerily similar to what we experienced with the other PSR railroads in terms of their response back to us. From CEO down, they understand the details of what happened that created a service issue, what it takes to correct it, extremely detailed, really from top to bottom in that organization. So I'd expect that as they operate like that, they'll look more like CSX, and they're going to be able to provide a high level of service as the market grows.

I'd be interested to learn more about the potential of the CPKC partnership. To what extent does that unlock more volume opportunity? To what extent is that accretive to your overall intermodal growth outlook?

Yes. Garrett, I'd tell you, the most underserved conversion from over-the-road to intermodal, we would assess to be Mexico, for the lack of a product to this point that you could rely on. We had fits and starts and couldn't really rely on it. The customers, therefore, chose over the road as the solution. So it's, in our view, very target rich. And then, when you look at the performance that we're getting and that I expect that we'll continue to get, it's a very attractive market for us. And it opens up some new doors that historically we haven't played, particularly in the automotive market as well. So not only what's also being a huge reinvestment of foreign investment dollars, I think it's up 60% this year over last year on this whole near-shoring. So you look -- put all those trends together. We couldn't be more excited on what that means for us. It's going to be a much larger part of our operation and portfolio going forward.

And then looking at the pricing dynamics in intermodal, a lot of capacity across the industry stacked right now. We're working through a softer truckload market as well. Help us understand what's it like in pricing discussions. Can we see firming pricing on the intermodal side?

Yes. I don't think this is a matter of all the containers have to come off stacks before you see an inflection. I think this is similar to the end of 2017, where there was a mandate that impacted dray capacity that really changed the market. There were still boxes stacked back in 2017, and there was a pretty rapid inflection. And I think we're going to see that here, especially in California. ACF, Clean Fleet Act that implements here January 1. So as of January 1st, you can no longer bring a diesel truck -- a new diesel truck onto the dray registry in the state of California. Everything has to be a battery electric vehicle. And so over the last few years, there's been a little bit of a decrease in dray capacity, as well as typically your lever when you need to go outside and get some other dray capacities use a third party. AB 5 has been implemented in California. So owner operators are not -- which are primarily what makes up third parties are no longer an option. And that a Clean Fleet Act, whether you own 1 truck or 500 trucks in the state of California, it still applies to you. So potentially, that changes this pretty rapidly. And when you -- we saw that in 2017. Once that changed, it inflected very quickly.

Yes. And the resiliency will be will certainly be a challenge there.

For sure. Sir, please stand.

You guys talked a little bit just specifically about the last 8 weeks. I think service -- CSX service has been great. A fantastic deal. In light of what you're discussing here, could you spend just maybe an hour talking about the service levels you're experiencing today as well relative to what you experienced 6 to 12 months ago and maybe trying to contextualize that around how much more improvement you believe either exists...

Sure. So in front of us?

If at all. Maybe they're already there.

No, there's still opportunity in front of them. And so there is a pretty steep drop off. A couple of times, they had some washouts that took an extended period of time for them to be able to recover. And even at the level that they're at right now, we'd still say that there's an opportunity for improvement, and they recognize there's an opportunity for improvement. Still just getting into about 80% on time within 24 hours versus CSX, which has essentially been at 100% on time within 24 hours for more than a year now. I actually don't have to present their data. But we see that every single week and they're performing at that level. So it's -- there's still an opportunity for the UP to improve here.

The best-in-class level historically...

CSX.

For UP.

For UP. We only have this data going back maybe 12 months, is when they started having to provide that to the STB. So...

And that's our relationship length is about 12 months.

Yes, as well. But the public information only goes back about that far.

Just turning to intermodal profitability, incurred some higher repositioning costs during the quarter. Interested how the network is performing from a fluidity standpoint. Do those repositioning costs continue in the near term?

Yes. Do You want to take that?

Yes, sure. So there's opportunities to build a more resilient network. And that's both within our truckload business as well as our intermodal business that there's -- there just hasn't been a great match between some of those opportunities. And when you see that, you start to pick up within those head haul markets. You tend to push some empty equipment in there before you start winning all of the backhaul. And so do expect as conditions start to change, create some opportunities to be able to compete, especially against those kind of small trucking companies, brokers that are offering pretty low prices that will enable us to balance out our network and reduce the length of all the empty shipments.

Yes. Garrett, as I also say, we're now a year in. We've been through 1 early allocation event with this transition of a year ago with the UP. And so I think we're smarter together commercially. And where are the strengths and the weaknesses and what does it mean to work together to take a larger share. And -- we're not going to let those learnings, not be valuable to us as we go into 2024. And we'll have 6 months now under our belt with the CPKC. And a lot of joint activity has gone on in the last couple of months getting in front of folks to be prepared for their decision-making as they go forward in 2024. So part of this is we're just getting more time together and after a long relationship with a very good provider in the West prior to that. And so I feel good that, hey, now we've been through a couple of things together, how do we get sharper and be more effective as we go through 2024.

No. That's helpful. Maybe turning to the logistics business, clearly brokerage margins appear to be facing cyclical pressure as spot prices inflect. How is your model different? And have we validated the stickiness of power only?

Yes. Our model, while I think there's real advantages to be a logistics company tied to an asset-based carrier as well and the collaboration customer-wise. By the same token, you don't want to just be sitting there as an overflow model and your success is completely tied to the asset. So I think we have the right balance of being collaborative, but also that this is a stand-alone offering that has its own freight generation capability and can sell in the marketplace on its own. So that being said, we're also probably a little tougher and we're not in it for a hobby. And so we don't believe in market share to lose money. And so while certainly the premiums and all the distortive opportunities, it does best when there is some flux in the marketplace. And so our margins have certainly compressed, but we're not trying to gain share by losing money. And so we're a little more conservative in that regard. And we've been nicely profitable even here in the third quarter compared to some others. So the power only just gives us one other element. And it's been more durable and -- from a customer standpoint because it's very seamless. And we probably have taken a little bit more of their volume than we had intended for them to help some of our assets in certain locations. So it's probably kicked back to the asset house a little more than we would have expected here in the short term. So -- no doubt that this will be something that will be part of our repertoire going forward, and we see that increasingly being part of what our network offering is to our customers.

No, I'm actually proud of our margins and our brokerage business right now. Spot price is very different than 5 years ago, where it was largely a manual transaction across the industry. And now it's completely digital. There aren't people in between. The models are adjusting prices up to -- within every 15 minutes, they're changing. And so to remain profitable, part of it is the quality of your models, how accurate are they, how predictive are they? And if you get it wrong, you see what's happening with some of these small brokerages or even large ones that are going out of business. They just weren't able to predict what pricing would do. So I feel really good about our position there.

And we keep our 50-50 spot versus contract in that business. We don't vary too much depending upon the market. We think that gives us the best defensibility and the most durability.

That's great. I'm sure you're well into your '24 planning process. Help us understand how you build more flexibility into the plan. Macro risk clearly evident. But this time of next year, we may be having a different conversation as it relates to demand. So how do you build flexibility in the plan?

I certainly hope you're right, Garrett. We go through very much a scenario planning approach. What was our base case based upon what we think is the most likely outcome. And then what is the things that could happen and how would we respond? And as mentioned, our capital is fairly fungible. Our driver capacity is looking for the best opportunities. And we can deploy across really our dedicated network or intermodal dray to get after how do we optimize at the enterprise level, what our returns and contributions are. So we're expecting, as we go into the new year, we don't have quite the same price momentum in the network business we had a year ago. We don't have large seasonality behind us yet, but we also don't have that large overhang on the inventory condition that we've talked about. So I think we can respond, and our commitments to our customers have put us in a position where we'll respond quickly to put our assets and our capabilities to better returns, particularly in the network business.

That's great. And when you think about -- this has been a cycle of extremes, it'd be great to get back to normal. What does normal look like at Schneider? we've got some guideposts as it relates to margins. But help us understand a credible framework there. What you see these different business segments growing at longer term?

Yes. Let me just hit across that real quickly. At the highest level, we don't really see a cap relative to our dedicated growth there. But 300 to 500 units of a net growth, considering you'll expect some natural level of churn. And then let's, every 18 months or so, maybe more frequently, how do we feather in an accretive acquisition to keep advancing that strategy? We've laid out an intermodal that we're going to double by 2030. So think of that as an 8% to 10% CAGR. That would be more in line, particularly with what we think is available for the over-the-road conversion, the emissions, tailwind, that customers are going to have to start taking actions about the commitments, particularly the Fortune 100. And then we would see ourselves returning to our typical growth patterns in logistics after going through this, a very extreme condition in the low double-digit percentages on a volume basis. And particularly now that we've got a power-only offering behind that, we think that is certainly doable on an annual basis and something we have done for about a decade, and we would expect to get back to that.

Great. And when you think about just the mix of business, are you happy with how you've got the portfolio positioned? Or would you expect further changes or just natural outcomes from growth?

Yes, they're all different capital intensities. They have different margin profiles. So our performance at the enterprise level is a function of that mix. And we -- overall, we initially threw out a target that we thought was best. About 50% of our earnings and revenue would come from a more asset-light intermodal and logistics and then the other half coming from our more capital-intensive and driver-intensive truckload operations. Dedicated success has pushed us a little higher there, and growth through acquisitions pushed us higher. So we don't have a magic number. We think they're all 3 investment grade. They're all operating at scale. But that guidepost maybe that 50-50 is still something that we think is an appropriate target.

That's very helpful. We appreciate the long -term perspective and an update on our current trends. So thank you very much to Schneider National for being here. Thanks, Mark. Thanks, Jim.

Thank you.

Thank you everyone.