Werner Enterprises, Inc. (WERN) Earnings Call Transcript & Summary

Good morning, and welcome back, everyone. Next up, we have Werner Enterprises, and we are very happy to welcome to the conference, CEO, President and Chairman, Derek Leathers; and EVP, Treasurer and CFO, John Steele. Gentlemen, thanks so much for joining us this morning.

Thanks for having us, Ravi.

Good morning Ravi.

Before we kick off with the fireside conversation, please note that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/research disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative and also for the audience, if you have any questions for Derek and John, please submit them via our webcast, and I can pass those questions on to the management team.

With that, again, gentlemen, thanks so much for joining us. Obviously, it's a good time to be a trucker right now. The macro is red hot. The hurricane disruption that we saw last month continues to work its way through the industry with record high rates. Derek or John, maybe you can kick off with just somewhat of a broad overview of what the environment looks like right now relative to 3 months ago and how do you see it trending over the next quarter or 2?

Sure, Ravi, I'll take that. Look, the broader environment remains very strong, as you indicated. It's been strong now for several quarters in a row. We've been running at fairly peak levels as it relates to capacity and how tight our network has been now for a few quarters. The hurricane impact you talked about certainly has had some effect on our network. In our case, it was more an effect of having to move equipment out of harm's way, reposition a lot of equipment, it didn't result in the level or magnitude of relief loads that we've seen in prior storms just based on the path it took and where it hit. But we certainly suffered some of the front end damage of it as it related to just equipment repositioning and cost of things as well as some opportunity, obviously, for relief activity.

Got it. So just kind of going back to the last time we had real weather disruptions, which is in February, I think a lot of the industry took several weeks to kind of recover from that and that actually hurt numbers to a great extent. We haven't seen anything like that in the third quarter, right?

Well, I don't know. I mean, I think it depends on your network. Certainly for us, I would say it's probably been a net negative in the quarter, just based on the reality that we have a lot of dedicated fleets in those impacted zones. Those are not fleets that tend to then replicate the surge opportunity after the fact or premium pricing type opportunities, but you do have the impact of down trucks and days out of service as well as repositioning costs. So it's probably a company-by-company specific. For us, it was probably more negative on a net basis, but it was transitory. So obviously, we're getting through that. We're back up and running. Those trucks are moving, and we'll move forward appropriately.

Got it. So just kind of looking at the overall macro at a higher level, clearly, kind of when you look at the trucking space, you had to divide it on the demand side and the supply side, let's tackle the demand side first. Again, overall macro seems pretty strong, but at the same time, our shipper surveys have come back saying that ex-auto inventory actually looks kind of reasonably normal. What are your customers telling you? Are they still kind of struggling to fill up their supply chain that is struggling to fill inventory? What innings do you think we are in on the demand side of the equation?

Yes. I mean I think demand looks pretty strong as we look forward for the foreseeable future, driven by a few items. I mean, I think the consumer is still very engaged. There's still a lot of cash out there in the system, in the network, if you will, lot of infusion going on that's driving demand. I think on the inventory side, although it's in the supply chain, as you stated, where it's not as in the stores. And so it's in their networks. It's coming. They see it, they know where it's at, but it's not actually near even the final DC, let alone the stores in many, many cases, in conversations we've had. So that's one of the things that gives us a lot of confidence about how demand looks through the end of the year as well as into '22 because there's a lot of work to be done to get that stuff through the pipeline.

Got it. And then moving on to the supply side. I mean, here is clearly where there's kind of more of a structural issue and more of a sector-specific issue, if you will, with the driver shortage and availability of new trucks. Can you talk about that at all, maybe starting with driver availability? Are you seeing any improvement there at all? And how much improvement do you need to see before we get back to normal?

Yes. So the drivers aside is this stuff as I've seen still, it remains very, very difficult market. I don't foresee that providing us any relief in the short or in immediate term. We're taking some company-specific action on that front and we've talked about getting to 22 schools by the end of the first quarter of '22. We came into the year at 13, 14 schools. We had one that was opening. We've added several already. We'll add several more. That's provided some relief as extended unemployment benefits have ran out, there's been a little bit of impact, but I really would caution it's been very slight. Most of those extended unemployment folks, where we'll see the benefit of them as taking jobs in warehouses, moving equipment more fluidly. We've all talked about how our equipment is just not being optimized right now by the customer side of the equation. A lot of well-timed at customers, both shipper and receiver locations, they're sitting on lots of equipment. It really hurts production and it has negative impacts across our network. But it's not negligence on their part. They just don't have the labor resources to be able to chew through the equipment. Our job is to make sure that despite the fact there's going to be negligence, we've got to work hard to get compensated for it. So the driver side, though, I think, in total, is going to be an uphill battle for really quite a while. The equipment side, you mentioned is probably more front of mind, honestly, right now because we've been battling the driver stuff for a while. We've got a lot of programs in place to try to hold our own or hold the line on the driver front. But the equipment front is getting much worse quickly as we indicated even as far back as our Q2 call, we kind of intimated that we thought it was going to get worse in the back half, it's definitely gotten worse. It's impacting new equipment. It's impacted parts. It's impacting fluidity in the network. So there's a lot of concerns I have on the equipment side. I think those large well capitalized carriers like Werner will get through it better than most, but absolutely will not get to it unscathed.

Got it. So Derek, maybe we can unpack that point a little bit more. Again, you guys pride yourselves on having one of the youngest fleets in the industry. Is the net impact of this going to be that your fleet age -- just ages a little bit. It shouldn't be too much of an issue because you already have, I think its 1.7 or 1.8 years, a very young fleet. Or kind of what are the implications of this? Does this have any impact on your ability to grow the top line at all?

Well, so the short answer is yes. It does have some impact. We were really about 1.9 to 2 is kind of where we were at closer to 2 and 1.9. That's where we want to be. So that was going into it, we were where we wanted to be. But we will see some aging of the fleet in the back half and probably even into the first half next year. I don't suspect you're going to see us wake up at 2.3, but you could see a 2.1 number in our future. We're going to work hard to get through that. And that -- so it has the aging effect, but the bigger of the 2 impacts right now for us, at least, is the impact on the day-to-day operations when trucks go down, and it's the simple part, but you just can't get your hands on parts right now. Those delays, the number of trucks down greater than 24 hours, which our network is usually -- you can almost count them on your hands. Now you definitely cannot. And so you're seeing days where that number has crept up significantly, and we work it down. And then something else, there's a new shortage on the horizon that we fight through. And so we're trying to get creative. It does help that the fleet is newer. So the impact is lessened by that. You don't have as many breakdowns when you have a fleet that new. But sometimes, it's just a simple minor part failure, but the availability of those parts is extremely tight right now.

Got it. And maybe one related kind of tailwind to that is the used truck market has been pretty hot, and you and your peers have done really well, kind of trading in your trucks. What do you see the outlook there, kind of does that extend into '22 in your view?

Yes, we think so. I mean, we sell our own trucks. We have one of the largest used sales network in America. We sell our trucks. We're doing very, very well on a per unit basis there. But we're also hedging our bets quite a bit. We're playing that pretty conservatively right now with the lack of reliable data coming on new trucks and knowing when we'll receive new trucks. The last thing I want to do is going to peek under truck. And so we're not -- the frustrating part of sitting in my chair is one of the hottest used truck markets out there that we've ever seen, demand for those trucks is as high as it's ever been and yet we're having to really think and be thoughtful about what kind of volume we're going to sell. And as a result, really kind of end up with some excess assets at times in the network, just again, transitory, this quarter, maybe a little bit in the next quarter as we await to see the deliveries of some of the new trucks that we're waiting on.

Got it. You referenced peak season. Can you just expand it a little bit more? What does peak season look like this year? Kind of is it possible to tell already? This time last year, there was a lot of uncertainty as to what piece would be like? Would you be able to resource for it? Do you feel like everyone has a little more visibility this time? Or is it worse?

I'd say the visibility is a little better mostly because we saw a lot of people working hard to move some of their peak season shipments up, and they've been working kind of at peak levels, both on the supply side, as truckers as well as the demand side, shippers and receivers have really been moving aggressively toward kind of peak volumes for several quarters. But specifically, in Q2 and into Q3, we've seen a pull forward of some of that peak demand. The good news is that gives us more time to work it through the network, and we need that time right now because we're already kind of at such an oversold environment. Bad news is it doesn't necessarily compress as much of it into a shorter time frame where some of the really big opportunities for project type freight may not be as widespread. And again, that's both sides of the larger issue. We couldn't ramp up like we have in prior years because we're already going into it more choke fed. They want to avoid any disruption. So they've spread it over longer periods. There's still pricing opportunities in that because it's still above and beyond our agreement levels, if you will, but it's going to be more smooth versus as spiky as maybe what we've seen in years past.

Got it. You guys have never been much of a spot trucker. But if this is going to be an environment where -- which is going to be kind of higher for longer, if you will, kind of have you looked into potentially playing a little more in the spot market?

Yes, it's something we're actively looking at all the time. We want to always stand by the folks that have stood by us. We want to do the right thing, if you will, but the right thing is there's a known opportunity cost of not doing more in the spot market, and we have to have open honest dialogues with our shippers about that just like they would have open dialogues with us, if they could go place that freight in the spot market and they would if they thought it was going to save them a bunch of money. It has not resulted in a sudden increase in our spot exposure, mostly because customers respond to that as you would hope they would and say, well, what do we need to do to work this out. So our spot market exposure on our one way network kind of remains in that very low double digits to high single-digit type range. It hasn't moved a lot, even though we've actively looked to try to get a little more exposure there. But the reason it doesn't move is because we're convinced through renegotiated agreements to not move it. And so right now, that we have not done more of it. We've done more freight at better rates with existing customers a result of how hot the spot market is, but not moved any kind of wholesale shifting of trucks into the spot market.

Got it. One of the unique aspects of Werner is your extremely strong dedicated franchise, it's almost 60% of your trucking business. It seems like it's one of the fastest-growing and strongest parts of transportation, any kind of transportation anywhere. How would you characterize the dedicated market right now? Are we at peak for dedicated or do you think there's more interest from customers to convert their fleets to dedicated, given what appears to be a prolonged disruption here?

Yes. I think the interest level is high and will remain high through '22. I don't think we're at like peak levels as far as the interest level, but the issue will become working through that pipeline and making sure that what you're allowing to get all the way through is stuff that's long term, sticky kind of dedicated agreements. It's not just shelter agreements to shelter from the spot market or shelter from one way pricing. That's where the real work goes on. And so we've got a robust pipeline right now. We'll keep working through it. We've been performing very well and dedicated. As I mentioned earlier, our dedicated took its lumps this quarter, specifically as it relates to storms and what happened down in the southeast as well as there's parts availability issue. But overall, when I look at a longer horizon, I'm as bullish now as I've ever been on where dedicated heads long-term and what that pipeline looks like and the quality inside of that pipeline that we're able to kind of extract to go ahead and implement in our network. Our retention rate dedicated is high 90 percentiles. It stays there all the time. So once we get it in-house, we usually retain it for long periods of time and can improve upon it over time as well through increased efficiencies and backhauls and things of that nature.

Got it. You said high 90% retention rate for contracts and dedicated. What's the driver situation like kind of, is it materially better and dedicated compared to the one-way business?

Yes, I'd say it's better for sure. I know everybody's definition of materiality is probably a little different, but I definitely think it's a better lifestyle, it's better pay, get some home in a way that they know the work they're doing. They repeat that same work on a regular basis. In many cases, they're home nightly, doing the exact same work every day. So there's good retention there. There's good attraction there. We do tend to work inside of dedicated at work that's harder. So it's a little more driver intensive work. So it takes a special breed to want to be able to do that kind of work. And there's lots of drivers out there that like it. It's a less sedentary lifestyle to say the least. I mean, they're involved in many of our dedicated end loads. They're involved in participating with store activities and things of that nature. That's what makes it so defensive, but it also makes it a little bit more picky on the kind of driver put into those environments. But yes, in net, it's more driver friendly, well, more driver attractive. It may be more work for them, but it's more driver attractive because of the consistency of the work there as to perform.

Got it. I just want to follow-up on something you said maybe for you or for John. Just on the commentary on, obviously, the hurricane impact and the downtime for the trucks kind of hitting dedicated, is that something we need to keep in mind for 3Q on the margin side kind of being potentially a headwind? Or is that more than overwhelmed by what you're getting in terms of price?

No, I think it is something we need to keep in mind as a potential headwind. We get -- our contracts are set up, or we're still able to build through those assets because they're dedicated to that customer. But what you're not able to do is put the additional miles on those trucks and really be able to achieve the modeled benefit of that dedicated fleet. So you're going to get covered for your fixed assets and some of your fixed charges. But in this driver market, the one thing you have to do is pay those drivers. It's not their fault that hurricane game. It's not their fault that truck is not moving. You've got to make sure and pay those drivers. So it's a headwind on the driver pay line. When you look at it at a step per mile basis, it's going to be a noticeable headwind. But it's transitory. It's not all pay raises. It's just paying folks to not move, which is the most painful kind of payments you can make, but they're necessary and they're the right thing to do.

Got it. Understood. Derek, yesterday, we had a TL carrier point to the new potential vaccine mandates for large corporations, potentially impacting the driver pool. I think the CEO said that he thinks half the drivers out there, maybe unvaccinated. Does that statistic feel right? Kind of do you think there's going to be an impact, a very clearing house like impact if we start putting vaccine mandates on drivers?

Yes, I think it could be a significant impact. I don't want to scare people off right now. But yes, I think in our fleet, that half number is probably a fairly decent estimate. I think industry-wide, that's an overly optimistic one. Survey data and things we've done, I do not believe that the US driver population is at half vaccinated at this point. I think it's a group that's independent nature, independent thinker. They chose to be truck drivers for a reason. They don't generally like a lot of interaction or intervention from others. That's why they chose to be out over-the-road in a truck by themselves. I think that number is quite a bit lower than 50%. I think this mandate is very concerning. The thing that concerns us most and what we're kind of most upset about is the arbitrary nature of the 100 employee line being drawn. Last time I checked COVID does not focus on demographics or focus on size of company, and yet 90% of our industry is trucking companies with less than 100 employees, and they're somehow immune from COVID and immune from this mandate. So we want to be very protective of any potential migration that might happen as people do anything they can to avoid in their mind, the right decision, which we don't support. We're proving -- we're sending messaging. I was doing at a town hall yesterday with about 100 drivers here to try to talk to them personally about it, we are a pro vaccine. But this mandate thing worries me and it worries the impact on supply. Upside is it's yet another structural obstacle to any capacity being added in this industry right now because I think there's a strong willed group of folks out there that are going to simply say Thanks but no Thanks and if that means either migrating or just migrating out of the business, I think there will be some of that if this thing sticks.

Got it. Are you in conversation with folks in DC or is the ATA kind of doing some work here to get some clarity on this or --?

I would say all of the above and actively so.

Got it. Understood. I wanted to switch gears and talk about the logistics business, clearly, a huge focus area for you guys. It has been growing fairly well in the last couple of quarters. What role does this play within the overall Werner franchise? Again, is this -- do you view this as a support business for the trucking business long term? Or do you think it can be more of an independent standalone entity that can drive returns over time?

I think it's more of the latter. I mean as you think about what we do in logistics today, we are working actively to make sure we're not just covering overflow freight, we're not just substituting or doing service substitution work where they want a Werner truck and instead they're getting a broker truck, that group is out there actively working and developing and cultivating their own customer base, their own activity, both in the transactional and contractual market. They're operating with the appropriate level of independence so that they can basically provide us a buffer through some of these cycle changes because it tends to be countercyclical to what happens to our one way assets as an example and we want to keep it as independent as it is so that we do provide some of that kind of that cyclicality buffer that would otherwise exist.

Got it. And any thoughts on power only? I mean, clearly, you've seen that as a very fast-growing part of the brokerage business, especially for asset-based carriers. How big is it for you guys? How big can it be over time? And kind of what innings do you think are we in the power only adoption?

Yes. We're bullish on power only over time. It's going to take time to get there and get to where we think it ultimately ends up. If you look at our growth over the last several quarters, it's one of the big drivers of that logistics growth is what's going on in power only for us. We're in the early innings, not the middle innings. It's still early. We've got a lot of work to do there. It's not mandated or helped in any way by the OEM disruptions on the trailer side of the business because that's actually probably more significant than what's going on the truck side in terms of trying to get your hands on trailers and the trailing equipment we need. We've all but shut down the sale of used trailers right now in order to be able to continue to support both power only and our own fleet. But yes, it's early innings. We think there's a lot of runway left in power only. We think it still will be a big driver of our logistics results going forward. And that overall growth in logistics has continued as we've gotten deeper in the quarter.

Got it. Just to remind the audience, please do submit questions for the management team via the webcast, and I can pass them along. Maybe to switch gears a little bit and talk about the balance sheet here. You guys recently completed an acquisition that got you a bunch more drivers, was nicely accretive numbers as well. Maybe Derek, you can give us an update on that? How is that going? Is the driver retention rate as high as you expected? How is the integration going so far?

Yes. I mean the integration is going very well. The short answer is it's better exceeded our expectations as we thought about and modeled what we thought would take place post closing. We've had really good success with retaining the existing drivers, being able to be active and integrate it quickly on our recruiting machine relative to helping both them and us, make the phone ring a little more often. So it's been positive on that front. We found some of the synergies that we believe to be there and believe that we could get accomplished, and we've been working to implement those over time. We're obviously being careful and cautious because it's our first acquisition. So -- and we remain steadfast in our belief that the best play relative to DCM for us is to continue to run it as a stand-alone while finding certain areas, kind of more think of front of the house, back in the house, acquisition of assets, disposable assets, some of those type of activities where we think there's good opportunities for synergies, but the day-to-day dispatch of those trucks, operations of those trucks, customer support, ECM is continuing to be the point on those things.

Got it. Just again, continuing on the balance sheet. You had promised to be more aggressive with deploying the balance sheet. You've delivered a higher level of cash return to investors. You've completed a meaningful acquisition. What are the next steps here? Kind of how much more dry powder do you have?

Well, we're still in -- John feel free to weigh in, but we're still below our stated comfort level from a debt-to-EBITDA range. We talked about 0.5 to 1.0. Even post acquisition, we're really kind of below that range. That gives you a sense of sort of dry powder. We've increased our dividend several times over the last few years. We're going to continue to prioritize investing back in our business and growing our franchise at a time we think our franchise is executing very well. But everything is on the table relative to regular dividends, share repurchase, which we had started ramping up prior to Q2, where we shut it down as we focused on the ECM acquisition and future acquisitions where it makes sense. All of those things are being looked at. We do believe we have the dry powder to do it. But running our business will always be first and foremost. But I can tell you that we have an eye towards growth, and we want to make sure we grow this business over time. We're not going to just sit back and focus exclusively on margins, margins would be a priority always but we want to show that this can both be a growth company with a high level of margin performance.

Ravi, to add to that, so we expect to be a free cash flow generator over time. So you're seeing more consistent CapEx from Werner relative to the past where it was more volatile. And with improved margins and more consistent CapEx, we expect to be generating free cash flow to give us the opportunity for share repurchase or acquisitions or increase in dividends.

Got it. That's great. Speaking of kind of not sitting back and focusing on solely on the margins, you guys are one of the leaders in the space and looking at the next-generation of trucks. I think you were the first to run an electric only dedicated operation for a customer in California. You have an investment in too simple. You have a partnership with Embark on the autonomous side. Derek, maybe you can kind of quickly spend a couple of minutes talking about how you -- like what work you're doing to make sure that you're at the forefront of the next-generation of technology.

Yes. So one of the things we've done is we stood up several years ago, kind of an internal innovation council that's got representatives from across the aspects of our business, everything from maintenance to operations, to the IT, et cetera. They're constantly trying to stay at the forefront of all things that are out there being developed. I do a lot of my own homework as well as all of the updates that I get from them. We're very close and spending a lot of time, staying close to the autonomous developments as they get closer to potential production capabilities as well as electrification. And we still think those things are kind of a little further off than some may think. But the tech is real. The autonomous tech is real and it's coming. Electrification is real and it's coming. On the electrification side, in particular, it's still pretty expensive, even with any kind of incentives and pretty range bound and weight bound. But over time, they'll get better at that. So we're going to stay very entrenched with all of the above. We've got aggressive carbon footprint reduction plans that we've stated as part of our ESG efforts. And we're going to meet it. And the only way to get there is with alternative technologies. We're not going to be able to get there with clean diesel alone. We do think clean diesel is kind of underrepresented in the conversation because the advancements that continue to be made there and the reliability of that technology is second to none. So that's going to play a role in our view for the next decade for sure. But we will be supplementing it where we think it would make sense with electrification, potentially hybrid and strategies as they develop and come to fruition.

Got it. You guys recently kind of added a sixth element to your 5D plan, kind of focused on ESG. How much does that come up in customer conversations these days? Is that again something that you do in the last 5 minutes? Is that something that's a fairly meaningful part of the conversation? To what extent are your customers' decisions on picking a transportation provider, logistics provider driven or kind of highly influenced by ESG these days and when you hear of the railroads trying to make a big push, they're saying that, hey, the rails are greener than trucking. What are your thoughts on that? I mean, clearly, kind of when you look at the end-to-end move and the speed of the move, do you think that's something that can sway customers over time?

Yes. So I'd say right now, as one would expect, with capacity being as tight as it is and with customers scrambling to get inventory levels to where they belong, ESG is not at the forefront of those conversations. But I absolutely believe that it is here to stay. And our view on it is we want to be out there in front. We want to lead on that issue. We want to show how committed we are because this too shall change. I mean, at some point, when things stabilize and get a little more normalized, in our view, probably 2023, when that happens, maybe late '22 at the earliest, that ESG thing will come up, and it will come up quickly, and we want to already have a great story to tell. As far as the rails look, I'm not going to fight gravity, right, there are environmental benefits to moving intermodally, that freight, which can move intermodally. But they're not going to move freight, ESG is not going to be the primary driver of how they choose to move their freight. If the transit times are too slow, if the service levels are insufficient or if it just simply doesn't fit the PSR model, which is a large, large slot of freight out there that does not, that's going to move by truck. So our job is to make truck as environmentally friendly as we can so they can accomplish both their ESG mission as well as their service expectations. So we've seen, if you look even nationally over the last year, that truck to rail conversion not only has slowed. If anything, you've seen in a lot of cases where it's going the other direction. PSR works very well. It provides for great returns for those railroads, but it does sort of limit the footprint in which they can operate and limit what kind of freight they can put through that network. And that freight that fits it, it's going to go that way. And that's why our intermodal franchise is growing as rapidly as it is. But there's an awful lot of freight, an awful lot of freight that's not going to fit that network. It's going to stay on truck for the foreseeable future in my view.

Got it. That's a great way of putting it. We're almost out of time, so maybe one last question. I don't think it's too early to look out to 2022, I think maybe having your first conversations with customers on next year's rates. Our surveys have come back at a starting point of about a 5% rate increase next year compared to this year. If I were to consult a crystal ball and tell you, hey, the 5% rate increase next year, would you be happy, disappointed? Would you take it or not?

I mean, I would take it and be disappointed probably. I mean we see -- we're going to work to get what the market, can bear with the market and frankly, what our assets deserve. And if you look at the pressures, the disruptions we're dealing with right now, everything from delta variant to equipment supply to inflationary pressures, up and down the P&L, I don't, at this point, I believe 5% is going to get that done. So we're going to have to go out and do what we need to do to make sure that we are protecting our margins, if not looking to expand our margins where possible. I think the market will support it. I think the supply demand imbalance remains consistent through 2022. And so we're going to go out and work aggressively to make sure and have the tough conversations that we need to have. And if we can't get there, we've got the largest dedicated pipeline we've seen in a long time, and we're going to continue to lean into it. And it will be -- we'll provide optionality to those customers, different options to get them where they need to get. That's why we like being mode agnostic and providing brokerage intermodal, one way and dedicated solutions to them, but we're going to have to have very frank, very open conversations about what it's going to take to get that blue truck or that brokerage solution in their network. And I stand fast on that because it's a very good time to be a trucker from a demand perspective but we are also juggling an awful lot of balls right now, and that's going to have to be respected if we're going to be able to provide that service.

Great. That's a great summary to close. It's going to be a fascinating 12 months. Derek and John, Thanks so much for joining us today.

Thank you, Ravi. Appreciate it very much.

Thank you, and this does conclude the presentation.