TFI International Inc. (TFII) Earnings Call Transcript & Summary

Great. Welcome back, everybody. Next up, we have TFI International. That just happens to be, by far, the best performing stock in our coverage year-to-date and since the beginning of 2020 as well driven by both organic as well as inorganic catalysts. So plenty to talk about today. And joining us is CFO, David Saperstein. David, thanks so much for joining us.

It's a pleasure, Ravi. Thank you for hosting us.

Great. So before I get into Q&A here, just keep in mind that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures (sic) [ www.morganstanley.com/disclosures ]. If you have any questions, please reach out to your Morgan Stanley sales representative. And for the audience, if you have any questions for David, please submit that via the webcast, and I can pass those questions on to David. With that, David, again, thanks for joining us. Obviously, a very strong macro environment out there. Can you just give us a sense of how things have been trending in the last few months or so. I think it's pretty clear that the truck market is still very, very tight in the U.S. It's not as obvious what's going on in Canada. So any color you can shed would be really helpful.

Yes, absolutely. I mean the environment has been very, very strong across all of our businesses. The Canadian market has -- it reopened nicely. Vaccination rates are very high. And you see that. You see that in the results in Q2. You see our LTL coming back in Canada, the revenue is recovering. And because we were so tight on the costs, delivering a 78% OR in Q2, packaged businesses are doing very well, both on the P&C side, our network business as well as our same-day business. And the labor situation in Canada of course, is -- it's not dissimilar to the U.S., but it's not as bad. It's not as pronounced. The teams are doing a really good job. We have low turnover and things are -- things are stable from that perspective. So we're really happy about what we're seeing there. And then in the U.S., it's a very, very strong environment, very strong demand environment in LTL, a strong demand environment in the parcel business on the same-day package delivery, which we operate in the U.S. as well as in the truckload side. And labor is an issue, recruiting is an issue, retention is an issue. So productivity of the assets is impacted to some extent, but it's also offset by the high productivity of the assets [ that are seated ] and the pricing that we're seeing.

Got it. I'm going to dig into each of those in a second. That was a great summary. But correct me if I'm wrong, when you guys did your 2Q call, the vaccination rate in Canada wasn't as high then, but it's like -- it's really high now. So have you seen a real surge in reopening demand, both B2B and B2C in Canada? Could that be a nice sequential tailwind for you guys going into 3Q?

I think it's just a continuation. It's just a continuation of the reopening that we saw taking place over the course of Q2 and is continuing into 3Q.

Got it. Understood. So when you look at kind of how things have trended so far obviously, peak season is something that's really hard to call. Again, this time last year, has been -- everybody was really nervous about what peak season would look like, how much you need to staff for. How does that look this year compared to last year? Do you feel like you have more visibility, especially in the B2C and e-commerce driven businesses? Do you feel like you have the capacity? And do you think you'll see the same step up in seasonality that you normally see in peak season in [ relative years, ] this year as well?

Yes, absolutely. I mean I think that this -- as always, we're just judicious with our capacity, okay? We run lean. We keep our costs in check. We don't like adding capacity when there's no return on it. And so as a general rule, this year is no exception, we're just very careful about the business that we take on. We make sure that we're getting the right returns. And where we can and where it makes sense to, we add capacity. And it's the same this year. We're operating in the same kind of labor constraints that everyone else is. And we'll work through it. But overall, this environment is very positive for us.

Got it. You guys are very clear about the fact that your view on -- your view towards e-commerce changed during the pandemic where initially you kind of thought that it was not a business you could gain a good return on, but then you saw that opportunity going into the pandemic. Is that now a permanent change? Or do you still feel like you're being opportunistic and tapping that return while it is there, but that normalizes over time.

No, this is absolutely a permanent change. So this was a business that we used to turn away because we thought we couldn't do it profitably. We thought that our number of packages per stop would decrease substantially if we did e-commerce. And frankly, if we had tried to just grow it outside of the pandemic, it may -- that may have been the case. But what happened with the pandemic was we had this avalanche of demand, unlimited demand it seemed. And so that allowed us to pick and choose the ZIP codes that we go to. And I'm talking in particular for our P&C. And so that's what we've continued to do. And so in the ZIP codes that we go to, we have similar density on e-commerce that we do to B2C because when you think about an apartment building in a city, similar density to an office building, right? So that's the kind of thing that we're doing. And this is a permanent change for us. And that's why you've been seeing strong organic growth in that segment with margin expansion as the operating leverage comes through and it's a change of mindset for us, and it's a change of outlook for us.

Got it. I want to dig in that a little bit more. Clearly, to your point, the volume change is probably permanent -- there may be some level of customers going back to store, but I think a lot of the e-commerce conversions are here to stay. Has there also been some structural change in the way e-commerce supply chains work where there is more opportunity for regional players, not broad network players, but just like smaller regional players to, like you said, come pick and choose regions, do more last mile -- kind of are you seeing the supply chains changing at all to kind of potentially do 1 day and same-day delivery that gives you more of an opportunity?

Yes, we absolutely are. We're seeing that. So we operate now switching, we're talking earlier about our P&C, which is a network business. We also operate same day in Canada and the U.S. in our logistics segment. And so this is exactly the segment that you're referring to. And for sure, this is a very low cost, fast way for retailers and e-commerce companies to fulfill their deliveries to their customers. We're in the cities where the final destination is and it's same day and you're not touching the package. It's not going through hubs and line haul and all that. It's just in and out of the facility within a couple of hours, and it's only traveling a few miles, and it's very, very cost effective. We're seeing very good growth in that business. We have seen very good growth in that business in Canada. In the U.S., we've seen -- we've really been working on the margins. It was an underperforming segment from a margin perspective relative to the Canadian performance. And so the Canadian team came in over the last 6 or so quarters, done a fabulous job of improving the margins, and we really see that in the results over the course of the past year in that segment. And now we're focusing on the growth on the organic growth. And some of our peers who are regional kind of same-day providers have experienced a lot of growth over the last few years. And we think it's fabulous. We think it's a fabulous place to be, and it's just a natural extension of the way that e-commerce is being delivered.

Got it. I want to switch gears and talk about the TL business. Obviously, very strong fundamentals there, very strong price environment. Can you talk about, again, how that is trending on the pricing side? Have you started having your first few conversations with your customers about 2022? What does that look like right now? And also, the flip side of that is on the labor side of things, you alluded to earlier in your comments, but a little more detail on what the driver situation is like for you guys and what that means for your fleet count?

Yes. So the important thing to remember about our Truckload segment is that it's really composed of 3 parts. The first is specialized truckload which is the tank business, the liquid bulk business, the dry bulk business, end markets so things like agriculture, food, chemicals, and that's in Canada and the U.S -- some flatbed as well, Canada and U.S. Then we have the Canadian market, the Canadian dry van business. And then we have the U.S. dry van business. And those are all -- they're quite different, actually, in the returns profile. So when you look at the specialized truckload and the Canadian truckload, the ROIC after tax is 12% to 13%. We published the numbers in our MD&A. Whereas on the U.S. dry van side, it's more like 5% to 6%. So it's quite different. And the reason it's different is that we're less capital intensive in Canada and in the specialized truckload business, we also have bigger barriers to entry. You also have a much more -- you're much more intertwined with your customer. You're delivering an input into somebody's production process, right? So as opposed to just kind of an end product to a fulfillment center -- to a store. So different dynamics. The specialized in the Canadian, the demand environment is strong. The rate environment is strong. It's not so much like there's a bid season, and we're just now talking about '22. It's kind of a rolling -- a rolling pricing environment, and it's positive and it's stable. It's not too volatile. And same thing on the labor side. Those businesses, our guys are not out on the road for 3 weeks at a time. They're doing loops, typically, the geography of Canada even on the dry van side is such that long, long journeys East-West are done on the rails. So the truckload is doing more regional kind of journeys. People are home more frequently. Same thing on the specialized side. It's more of a dedicated kind of situation. So the turnover is low. Turnover is low. We're able to give our people annual wage increases and things are stable. On the dry van side, we're seeing on the U.S. dry van side, we're in the same market as everybody else. So the rate increases or the rate environment is strong. Our capacity or demand is significantly in excess of our capacity, but [ R&C discount ] is too high. Our turnover is too high. And that offsets some of the benefits that, that we see from the pricing the productivity.

Got it. That's very helpful detail. Just 1 follow-up on that. Kind of do you see the potential for that U.S. dry van ROIC to close the gap to the other 2 segments? I mean, obviously, it's not going to happen overnight, but with these regulations kind of if that reduces some of the competitiveness in the industry by pushing out some of the marginal players, is there some way to reduce the capital intensity of the business? Do you see that gap closing over time?

Can we improve it? Yes. Will it close completely? I don't know. What we're doing is we're merging our main divisions in our U.S. truckload. We're putting them together, and this is going to allow us to be much more efficient and not have duplicative fixed costs across 2 platforms. That's the main operating improvement that we're driving right now, and that's within our control.

Got it. Switching gears a little bit to what is fast emerging as the crown jewel of TFI, which is the LTL business. So a bunch of questions here, but maybe we can start out with the overall environment in U.S. LTL. Obviously, kind of very, very strong fundamentals there as well. Again, do you feel like you're getting to a point where with some of the kind of spillover tonnage from TL to LTL, kind of the tonnage there looks peakish? Do you think there's more opportunity for growth? And what is the pricing environment in LTL look like, particularly in the U.S?

Yes. So with us, it's not like we're dealing with a fully optimized business, right?

That's an understatement.

We're producing a 75 OR that we're -- every little variation in the market, we're really going to feel it, right? Up or down. Us, we have huge territory to cover with things that are really unrelated to the market and to the macro, right? We have to make sure that the freight that we're hauling makes sense. We've gotten rid of -- I think we had a lot of shipments below $100 per shipment, right? Below $100 per shipment, we don't even need to know what the origin destination kind of [ carries on that. ] We know we're losing money, right? So we've taken care, we're taking care of that. We've had a lot of customers that were large customers that were significantly -- well, we were losing 20 points, 25 points. We're addressing that. We had -- we're reorienting with the sales force kind of focuses its attention and looking to smooth out the cyclicality and the seasonality of the business and focusing on freight that fits. So the market is great. No question about it. It's an opportune time for us to put through these changes. But we're going to be doing these changes no matter what, and they're going to benefit us no matter what the environment.

Got it. So last quarter was the first quarter you guys had the keys to the U.S. LTL business for the first time for a full quarter and the progress you made was outstanding. I mean, you -- the OR you printed was significantly better than what you thought you would. Was that a case of getting in there and just delivering on those cost targets quicker than you expected? Or did you just see a much larger cost and margin opportunity that you were able to tackle, again, in an expedient manner, but there still means that there's a lot more to come.

Well, when we published our Q2, we had only owned it for 2 months, right? There's only so much you can do in 2 months. So when a lot of the impact -- a lot of that benefit was -- or a lot of that performance was driven by some of the good repricing work that the team had done, let's say, in the 6 months or so before we took possession. And then once we got in, in those 2 months, we really started looking at the sub-$100 shipments and working on those, getting those out, starting to look at accessorial charges, things like that. We didn't have a chance to do anything really on the cost. And not much at all. I mean, 2 months. And even on the book of business, I mean, again, it's only 2 months. This is a -- even on the revenue side in terms of the freight, and it's not just pricing. It really isn't. I mean, in some instances, we're not asking the customer for more money, it's much more about freight that makes sense for us and makes sense that we can process efficiently. And so this is going to be an ongoing process over the next 12 months maybe or maybe even 18 months. And then all of the cost is to come as well.

Got it. So just given that potential, do you feel like the ultimate goal of OR there is much better than you initially thought the day you announced the acquisition? Or what are your long-term OR targets within the LTL business right now?

Yes. Look, I mean, I think what we -- we did move up our targets, right? So when we first announced the acquisition, we said we would be at a 90 OR within 2 to 3 years. And then when we came up with our Q2, we said that we'll be at a 90 -- a sub-90 over the course of a whole annual cycle within 3 to 6 quarters. So then the question is, okay, well, how far sub-90? Look, what we can do is give points of reference, right? One point of reference would be our Canadian LTL. Our Canadian LTL in Q2 was a 78. That business used to be mid- to low 90s operator. If you look at 2017, '18 and '19, that's where we were. What did we do in those years? What we bought, we bought a bunch of LTL companies. We bought NFF, we bought Normandin, we bought Cavalier. NFF was a distressed, above 100 OR operator. The other 2 were family-owned businesses, mid- to low 90s operators. And then we worked on them. We worked on -- we worked on the quality of the revenue, we worked on the cost -- we merged CF with TST on May 1, 2020. And the combination of all of those things, the accumulation of those assets and then the operating improvements that led us to today where we're running at 78. And 40% of our Canadian LTL is unionized. Then you can look at the -- and you can look at the U.S. peers and say, well, okay, is that another benchmark? And how do I think about the union in that context, right? And the union -- for us, the wage differential, it's closing, right? And the wage differential is closing between union and nonunion. Where our costs are higher is on the benefits. We have more generous pension and we have more generous medical. So that's a cost headwind. And there's probably some headwind around flexibility. But when you kind of put those 2 things together, you say, what really is the handicap? Maybe it's 4 points, 5 points, max relative to a nonunion player. So then the question is just how good can we be, right? Can we be like the best guy plus the handicap? Can we be like the second best or the third best? We have a very good track record. I think our team is outstanding. Our LTL team is remarkable. We have a great track record in Canada. And I'd say the best surprise with this acquisition -- because we knew we were -- we were very looking forward to taking possession and to being able to get to work. And the biggest surprise, positive surprise was how receptive the existing team is to everything that we're doing. The existing team here in Richmond, they're all in. They're all in, rolling up their sleeves, working with us side-by-side and really, really all kind of rowing this boat together in the same direction. And we feel great about that.

Got it. So maybe to just tie all that up. In the last 18 months since your U.S. listing, you guys have had an amazing track record of beating and raising to the point where every time you beat and raise, it sort of feels like the last meet and raise until the next one. So your latest guidance, the $450 million to $460 million, does that still feel as conservative to you, as the previous guides have been? Do you still have lots of opportunity there. Just trying to get a sense of diminishing returns on the beat, if you will, or if there's a lot more to come.

That's really a tough question to answer in the absence of a public earnings call. So I think that -- the best...

But you feel pretty confident. You're relaxed, you're like -- you're looking at that guide and you're like that's cool.

Well, for sure, we're very pleased with the way the business is going. Our team is executing very, very well. And we're very happy with things. And the best time to address that will probably be at our next earnings call.

Got it. Understood. Switching gears and talking about the other big driver of value creation for you guys, which is M&A. Again, you've spoken a lot about the LTL transaction. You've done a number of smaller transactions as well. What does the world look like to you from this point forward? Again, are you -- now that you've started digesting the LTL transaction, kind of are you back in the market for -- I think you never left the market for smaller deals, but are you back in the market for larger deals? Kind of what's the outlook look like for the next 12 to 18 months?

Yes. Yes, absolutely. I think like we said on the earnings call last quarter, we always have a pipeline. The small deals, the tuck-ins, those are going to continue. And we'll be seeing the normal course from us even over the course of the rest of this year. As it relates to the larger things, like we said on the call, for us, it's important when we make a big acquisition to make sure that things are going well, that we're confident things are under control. And things as we showed in Q2, things are off to a great start. We continue to feel very, very good about that acquisition. And so indeed, the timetable for another significant deployment of capital could be moved up. Typically, our historical cadence was something substantial every 3 years or so. But given where we are, given that our leverage is lower than we anticipated, given that the performance is better than we had announced when we announced the deal, that could be moved up.

Got it. Just on that point of leverage, can you just remind us again kind of what are your leverage targets? And how much dry powder do you have for a large transaction?

Yes. So in a steady-state sort of normalized situation, we would like to be between 1.5x and 2x. And I'll just specify that what I'm referring to is net debt to EBITDA, the way that our banking syndicate calculates it. So you'll see in our MD&A, how that is calculated, and it's kind of a normal way, but you'll see the definition there. So that's what I'm talking about when I'm talking about 1.5 to 2x. And that's in a normal situation. Now in the core around -- with an acquisition, could we flex up to 2.5x or so in that neighborhood? Yes. Yes, we could do that. That could happen. And then if we did that, the intention would be to delever rapidly to that 1.5 to 2x range and use cash flow to pay down debt immediately.

Got it. That's really helpful. We have a couple of questions here from the webcast in the audience. I think you briefly touched on this, but a little more color would be helpful. Have you encountered any challenges running a unionized trucking carrier? I mean, maybe if I could use another way, is it the best time to be a unionized trucking carrier given the labor inflation that's out there?

We've been working with unions all of our history, all of our history. And there are portions of our LTL in Canada are unionized -- portions of our P&C, right? Our P&C is wonderful. It's a diamond business, generates a ton of free cash, 20% margin. Part of it is union, it's okay, right? So this is something that is just managed. We work -- even if our employees are unionized, we work with our employees, right? We want to -- we were just out on a road show. Actually, the team, the TForce Freight team was going terminal, to terminal meeting with everybody. We -- they're still our employees, they are people. We care about them. Okay, we have a contract that governs the wages and the way that the hours work and the way that we organize ourselves. That's okay. But this is not a fundamental difference to a -- fundamental difference to the way that we run the business. So no.

Got it. And a little bit of a short-term question, but I think on the 2Q call, you guys made clear that you're working very hard to reduce some of the historical seasonality in the LTL business. Can you just remind us kind of how that's going and maybe how we can think about 3Q and 4Q relative to the first half?

Yes. Yes. So this business historically has had a lot of retail customers. And that's why the seasonality was pronounced in this business. So how do you address that? Well, the first thing you can address is the quality of the freight so that at least in certain months, historically, in certain months, the business has actually lost money in Q4 and Q1, in certain months. So with the improvement of the quality of the freight, we no longer expect that to happen. So that's the first piece. The second piece is, of course, the nature of the customers and moving a little bit more towards industrial, right, as opposed to retail. That has the benefit of smoothing out the seasonality, also has the benefit of reducing cargo claims. I mean us, our cargo claims are 1% of revenue, that's high, right? That's high relative to the good peers out there. And part of that is improving the operations. But part of that may also be the nature of the customer.

Got it. I think we are fresh out of time. So David, thanks so much for joining us. Clearly, many levers in the story here, with many more to come and you certainly have a lot of dry powder in the LTL business. So very excited to see what happens from here. Thanks so much for joining us today.

It's a pleasure, Ravi. Thank you very much for hosting.