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There are three fundamental bull arguments for C.H. Robinson (NASDAQ:CHRW): (1) the truck brokerage industry penetration is only 15% of total U.S. trucking spend (2) non-asset-based business model drives 30% return on invested capital and 25-30% free cash flow as a percentage of net revenue (3) Robinson's large network of truckers, shippers, local offices and brokers is an economic moat. However, there are headwinds to the company and the truck brokerage industry:

  • Mid-sized truck brokers, by investing in centralized IT systems, are enjoying higher growth rate. Robinson's network isn't a moat as there is little pricing power against shippers and truckers.
  • Intermodal rail is taking freight volume from truckload
  • Shippers and truckers are thinking about logistics differently after the recession
  • Peak productivity limits operating leverage

Current valuation implies high-teen transportation net revenue CAGR from '13 - '16, almost 2x the net revenue CAGR from '10-'12, and continued SG&A leverage to mid-40s operating income / net revenue by '16 when management has stressed peak productivity. Management communication has been inconsistent. The company just paid 12.5x trailing EBITDA for Phoenix to expand freight forwarding when that business has slowed from double digit to mid-single digit net revenue growth.

Brad Jacobs, CEO of XPO Logistics, said this about truck brokerage penetration:

To me, truck brokerage penetration was a very important point, because my bet is that the $50 billion penetration - which is 15% of the total trucking transportation spend in the U.S. is going to increase significantly. If you look at the growth rates of brokerage versus trucking as a whole, trucking has mainly been going up and down with GDP. The outsourcing to brokers has been growing at two or three times GDP.

While that's true, The Street expects high-teen CAGR in Robinson, not just 2 or 3x GDP. Transportation gross revenue flows through two key variables, truck capacity cost and personnel/SG&A, before hitting operating income. Transportation net margin (gross revenue - truck capacity cost) has compressed. Operating leverage is limited when management pointed out that earnings growth would be primarily driven by net revenues going forward.

Intermodal is taking share from long-haul truckload

According to Mr. Wiehoff, railroads have been spending capital investment in intermodal services, by dedicating more trains to rails and expanding intermodal ramps. Intermodal is taking share because freight has become more containerized over last 20 years. It has become more difficult for long-haul truckloads to compete against intermodal when diesel prices are high and rail services are improving. Intermodal domestic containers volume has been growing at double digits since 2010 while Cass Freight Index has been stuck below 5% growth rate for much of 2012.

Domestic containers volume published by the Intermodal Association of North America's Intermodal Market Trends & Statistics report:

(click to enlarge)

Cass Freight Index - truckload volume

(click to enlarge)

Mid-size 3PL brokers are a serious competitive threat to C.H. Robinson

Truck brokerage was born during the deregulation in the 1980s. The industry is extremely fragmented with C.H. Robinson, the largest in the industry, having a 2% domestic share and many start-ups arranging truckloads with just a few guys and a computer. Working capital needs (receivable is around 2x payable) for 3PLs like CHRW, Echo Global (NASDAQ:ECHO), Landstar (NASDAQ:LSTR) and XPO (NYSE:XPO) make it difficult for small start-ups to scale up. For Robinson, with $1.5 billion transportation net revenue in '12E, acquiring start-ups with couple million net revenue would not be an attractive return on its invested time and capital. Mid-sized 3PLs like XPO, ECHO, and Radiant Logistics (NYSEMKT:RLGT) have been acquiring and they are showing 30+% 5-year gross revenue CAGR vs. 17% gross revenue CAGR at Robinson. To compete against Robinson's large local network of offices and brokers built over decades, these mid-sized 3PLs invested in centralized IT systems.

The business model of C.H. Robinson: Net margin and operating leverage

C.H. Robinson's operating income has two key drivers: net margin between the shippers' rates and truck capacity costs and personnel expenses/ SG&A cost. Transportation net revenue has grown 18% CAGR from '01-'08 and 8.5% CAGR from '09-'12E. Most freight tendered by shippers is going to the top truckers in the routing guide, with much less going to the spot market. Gross revenue growth comes from existing customer relationships by expanding existing contractual rate commitments when there is cost pressure from truck capacity. However, secular shift in shippers' attitudes towards logistics and truckload capacity cost will put pressure on net margin. Operating income / net revenue has increased from 30% in 2001 to 43% in 2012E from lower telecom rates since early 2000s, better real estate management, a higher percentage of personnel compensation as incentive based and shared services. However, peak productivity will limit further operating leverage in the out years.

Secular shift in how shippers manage inventory and truckload capacity cost

Shippers have been managing their supply chains differently after the recession. A few logistics departments I spoke to discussed how they now focus on turning the inventory over as quickly as possible and carry minimum inventory for better liquidity and flexibility. Companies didn't have the traditional inventory ramp around the holiday in the past few years. Mr. Wiehoff explained why shippers have been reluctant to accept rate increase during Q2 2012 earnings call:

For the most part, it's the cost pressure and how they're running their business. The lead variable is how they're thinking about service and inventory and expedited charges and whether they'll roll the shipment over to the next day or make three more phone calls before they'll accept the price.

With economic uncertainty, companies focus on saving cost from the supply chain as aggressively as possible. As a result of low inventory level, there hasn't been a lot of unplanned freight in the spot market for truck brokers like Robinson.

Truckload capacity cost has steadily increased due to EPA emissions requirements, high diesel prices and driver wages. The net effect will subtract capacity. Truckers have complained that new truck equipment is 20-25% higher in this cycle. Even replacing equipment rather than growing the fleet would mean higher operating costs. This is a secular shift that shippers are managing inventory down and stretching the supply chain while truckload capacity is going to be permanently more expensive. The shift would put pressure on the transportation net margin.

The Cass Truckload Linehaul Index™ measures per-mile truckload pricing.

From calling out difficult margin comps to predicting margin normalization, management seems to have given up on discussing trucking margin:

Extracted from various earnings calls:

Q2 2011 - Question: Can you just take us through the quarter a little bit with some of the pricing and the volume trends that both Y/Y came down a little bit on the Truck side? Answer: It really is more about comparisons over the previous year.

Q3 2011 -- And the trend that we've been seeing throughout the year is that margin comparisons are getting more difficult and net revenue margin growth is going away.

Q4 2011 -- So if we have this balanced market and things go fairly according to plan, at some point our margins will at least normalize and there won't be net revenue margin compression

Q1 2012 -- We were maybe a little bit surprised that the market didn't tighten over the last couple of years.

Q3 2012 -- Question: So when you talk about pricing being flat and truck costs being up, are you indicating then you're still seeing that compression going on or given the net was up sequentially, that you feel that you've turned the corner on expanding those margins? Answer: It's been difficult enough the last couple of years that I really can't make that prediction.

Any operating leverage left in the model?

Management has been inconsistent on operating leverage:

When asked how much further can operating income as a percentage of net revenue can progress during Q4 2011 earnings call, management:

feels very good about the sustainability of the progress that they have made. And that mid to high 40s% is probably achievable over a period of time that they can continue to leverage their network and gain some further productivity enhancement" (Q4 2011 earnings call).

During Q1 2012 earnings call, management said they:

have been talking for quite a while that they don't expect the same type of margin expansion going forward and that they expect periods of volatility where maybe one will grow faster than the other, but overall, the primary driver of growth will be net revenues going forward, and don't expect it to have that same type of operating leverage that they have experienced in the last 10 years.

During Q2 2012 earnings call, management implied further operating leverage:

Margin percentage matters a lot, ultimately the productivity and the efficiency and the automation that's in the freight can result in operating income that is equally good on less margin freight if it's more efficient business.

During Q3 2012 earnings, management implied limited operating leverage -

Overall the goal of our business model is that our net revenue and earnings growth should approximate each other.

Operating leverage would be more difficult after acquiring Phoenix because freight forwarding is more administrative intensive. Management expected deterioration in net revenue per personnel -

Even with the investments in technology that we've made, there's a lot more clerical administrative type work involved in freight forwarding than there is in truck brokerage because of the complex documentation requirements.

No pricing power against customers...

Robinson's growth with existing customers has been greater than new customers or the transactional business. Robinson has limited bargaining power against top customers. To grow volume from existing customers, the company has:

made more aggressive price commitments, keeping rates flat to retain or increase volume" (Q2 2012 earnings call)

when there is continuous pressure from truck cost. Top 200 or 300 companies, which have a fixed rate matrix, are about 50% of Robinson's gross revenue. Since the recession, the percentage of that contractual business has moved towards "the high side, probably greater than 50%" (Q1 2012 earnings call). The company is taking share

disproportionate to the larger, more committed accounts, which comes with a longer term, more committed pricing relationship which gives it a little bit less short term re-pricing capabilities even though management are not extending past the typical annual bid cycle" (Q2 2012 earnings call).

According to Armstrong & Associates, General Motors, Procter & Gamble, Wal-Mart, PepsiCo, and Ford all use 30 plus 3PLs for logistics needs. Adoption of 3PLs by large companies won't be a growth driver as 93% of Fortune 100 already used one or more 3PLs.

…But what about companies that have outsourced their transportation solutions to Robinson?

Around 30 customers have outsourced their logistics departments to Robinson. The company would provide technology services, route guide management and transportation management type fee-based services. Those customers are usually Robinson's top 200 customers. Outsourced transportation services carry high degree of switching cost as they would involve integrating the customers' logistics systems to Robinson's 3PL system. These integrated relationships usually take "at least a few years, or in many cases much longer than that, to establish" (Q3 2011 earnings call) because Robinson has to earn credibility and learn the customers' businesses. However, outsourced transportation services have been less than 5% of total transportation net revenue since 2007. Using the broader definition of "outsourced services and integrated solutions" by the management, it was around 10% of transportation net revenue in Q2 2012. In addition, the topic has not been actively discussed since Q3 2011 earnings call.

2007

2008

2009

2010

2011

2012 9M

Outsourced services as % of transportation net revenue

3.21%

3.41%

3.71%

4.50%

4.15%

4.78%

Inconsistent communication

The operating leverage discussion is one example of management inconsistent communication.

Other examples extracted from past earnings calls:

Q2 2011 - At some point, we do need to see stronger economic demand and greater volume growth in order to sustain that 15% growth.

Q4 2011 - We don't necessarily need 15% volume growth to achieve our 15% revenue and earnings growth.

Q3 2011 - We were at peak productivity levels and if we were going to continue to grow, we were going to need to add people to balance that. Q4 2011 - We've always had some margin fluctuation but over time, our mix and our margins have expanded a little bit, as well as using productivity to gain some of that.

During Q3 2012 earnings call, management pointed out that:

the incremental freight that they have been able to get over the last year or two have fairly consistent margins across customers and regions (Q3 2012 earnings call).

However, Robinson has been expanding existing price commitments with existing customers while the cost of capacity has gone up.

Phoenix global freight forwarding acquisition: why now?

Robinson announced the largest acquisition of its corporate history in September, buying Phoenix for $635 million, to expand its logistics capability in ocean and air. Paying 12.5x trailing EBITDA for Phoenix, richer than most public freight forwarders are trading at, management believes the purchase price is fair. Even though Phoenix's earnings growth has slowed from 20% to mid-single digit, management believed that Phoenix

has continued to very successfully take market share and it's really around margin compression similar to Robinson. So, when they thought about valuation, Phoenix is a very desirable unique business. They were comfortable valuing it fairly consistently with how their own company is valued knowing that with the opportunities for very significant synergies and control premiums and unique business (Phoenix acquisition call).

Are there significant synergies between U.S. truck brokerage and global freight forwarding? The economics of truck brokerage and freight forwarding are different because:

there's a lot more clerical administrative type work involved in freight forwarding than there is in truck brokerage" (Phoenix acquisition call).

Most synergies are likely captured in the purchase premium by valuing the freight forwarder like a truck broker. During an interview , Mr. Wiehoff said the deal is driven by

how the world has changed in last 20 years with global supply chains and people moving manufacturing to other parts of the world to take advantage of cheap labor and all of the related transportation and technology requirements. The industry consensus is there is still going to be mid-to-high single digit long term growth. It may not be like the 80s and 90s in terms of double-digit growth. Management are not planning for the world to go back to where it was pre-recession but they are also not planning for things to be like what they are today,

The acquisition looks at the rear-view when productivity-adjusted manufacturing wage is already around parity between Mexico and China. John Pattullo, CEO of CEVA Logistics, believes that the ocean market is still dealing with overcapacity and freight is moving out of air into ocean and truckload. Customers are moving away from air freight in a market which is significantly overcapacity. Paying 12.5x trailing EBITDA for a single digit grower and digesting a different SG&A structure would make it challenging for Robinson to extract value from the acquisition.

Valuation

A reverse DCF is used to estimate what ballpark growth scenarios for the next four years are priced in. The model has two key moving pieces - the net revenue CAGR and operating income / net revenue ratio.

Static assumptions:

  • Gross transportation revenue 2012 - 2016 CAGR remains at 17%, similar to 2001 - 2012 CAGR

01 - '08 CAGR

09 - '12 CAGR

13 - '16 CAGR

17.3%

17.2%

16.5%

  • Terminal "normal" GDP growth would be 4%
  • Growth will be capitalized after year four
  • 10% discount rate
  • Receivable / payable remains around 1.87x similar to '11 and '12
  • CAPEX would be 2.5% of net revenue

The assumptions of net revenue CAGR and operating income / net revenue to match current valuation:

Net Revenue:

'01 - '08 CAGR

'09 - '12 CAGR

'13 - '16 CAGR

17.6%

8.4%

18.3%

Operating income / net revenue:

2011

2012E

2013E

2014E

2015E

2016E

42.4%

43.4%

43.9%

44.4%

44.9%

45.5%

In a scenario of low-teen net revenue CAGR and constant operating income / net revenue at 44%, there would be around 25% downside.

Reverse DCF Income statement snapshot (2001 - 2008):

For the Fiscal Period Ending

2001

2002

2003

2004

2005

2006

2007

2008

Transportation % of Gross

75.5%

76.4%

78.8%

82.9%

81.8%

81.2%

81.6%

83.1%

Transportation

2,332

2,517

2,846

3,597

4,656

5,322

5,972

7,130

Y/Y

7.9%

13.1%

26.4%

29.4%

14.3%

12.2%

19.4%

Sourcing

737

751

738

711

995

1,192

1,299

1,398

Y/Y

2.0%

-1.8%

-3.7%

40.0%

19.8%

8.9%

7.6%

Information Services

21

26

30

33

38

42

46

51

Gross Revenue

3,090

3,295

3,614

4,342

5,690

6,557

7,316

8,579

Gross Y/Y

6.6%

9.7%

20.1%

31.0%

15.2%

11.6%

17.3%

Purchased transportation

1,942.0

2,105.9

2,381.2

3,021.5

3,895.4

4,375.6

4,873.8

5,917.0

Transportation Net Revenue

390.4

411.3

464.7

575.7

760.3

946.0

1,098.0

1,212.6

Transportation Net Revenue Y/Y

5.3%

13.0%

23.9%

32.1%

24.4%

16.1%

10.4%

Transportation Net Revenue Margin

16.7%

16.3%

16.3%

16.0%

16.3%

17.8%

18.4%

17.0%

Souring Net Margin

6.1%

6.2%

6.8%

7.3%

8.2%

7.9%

7.7%

8.0%

Purchased sourcing products for resale

691.5

704.8

687.6

659.0

913.8

1,098.1

1,198.7

1,286.6

Net Revenue

456.6

483.9

545.0

661.2

880.4

1,082.9

1,244.0

1,375.2

Net Revenue Y/Y

6.0%

12.6%

21.3%

33.2%

23.0%

14.9%

10.6%

Personnel

225.0

236.7

279.0

334.1

427.3

515.9

568.0

601.8

Other SG&A

97.3

90.5

89.8

104.1

126.1

148.8

166.1

201.6

Operating expenses

322.3

327.2

368.8

438.2

553.4

664.7

734.1

803.4

Operating Income

134.3

153.2

176.2

223.0

327.1

418.2

509.9

571.9

EBIT growth

14.1%

15.0%

26.6%

46.7%

27.9%

21.9%

12.2%

Personnel improvement

-0.4%

2.3%

-0.7%

-2.0%

-0.9%

-2.0%

-1.9%

Personnel / Net revenue

49.3%

48.9%

51.2%

50.5%

48.5%

47.6%

45.7%

43.8%

Other SG&A / Net Revenue

21.3%

18.7%

16.5%

15.7%

14.3%

13.7%

13.4%

14.7%

EBIT / Net Revenue

29.4%

31.7%

32.3%

33.7%

37.1%

38.6%

41.0%

41.6%

Reverse DCF Income statement snapshot (2009 - 2016E):

For the Fiscal Period Ending

2009

2010

2011

2012E

2013E

2014E

2015E

2016E

Transportation % of Gross

78.9%

81.7%

84.6%

85.1%

86.5%

87.7%

88.8%

89.7%

Transportation

5,976

7,576

8,741

9,615

11,228

13,091

15,242

17,725

Y/Y

-16.2%

26.8%

15.4%

10.0%

16.8%

16.6%

16.4%

16.3%

Sourcing

1,555

1,643

1,536

1,612

1,693

1,778

1,866

1,960

Y/Y

11.2%

5.7%

-6.6%

5.0%

5.0%

5.0%

5.0%

5.0%

Information Services

46

55

60

65

65

65

65

65

Gross Revenue

7,577

9,275

10,336

11,292

12,986

14,934

17,174

19,750

Gross Y/Y

-11.7%

22.4%

11.4%

9.2%

15.0%

15.0%

15.0%

15.0%

Purchased transportation

4,768.5

6,302.5

7,296.6

Transportation Net Revenue

1,207.6

1,273.1

1,443.9

1,538.3

1,852.6

2,291.0

2,591.2

3,013.3

Transportation Net Revenue Y/Y

-0.4%

5.4%

13.4%

6.5%

20.4%

23.7%

13.1%

16.3%

Transportation Net Revenue Margin

20.2%

16.8%

16.5%

16.0%

16.5%

17.5%

17.0%

17.0%

Souring Net Margin

8.3%

8.5%

8.4%

8.5%

8.5%

8.5%

8.5%

8.5%

Purchased sourcing products for resale

1,426.7

1,503.8

1,407.1

Net Revenue

1,381.9

1,468.3

1,632.7

1,675.4

1,996.5

2,442.0

2,749.8

3,179.8

Net Revenue Y/Y

0.5%

6.3%

11.2%

2.6%

19.2%

22.3%

12.6%

15.6%

Personnel

597.6

632.1

696.2

705.7

830.6

1,003.3

1,115.5

1,273.4

Other SG&A

199.6

213.1

243.7

242.9

289.5

354.1

398.7

461.1

Operating expenses

797.1

845.1

939.9

948.6

1,120.1

1,357.4

1,514.2

1,734.5

Operating Income

584.8

623.2

692.8

726.7

876.4

1,084.7

1,235.6

1,445.4

EBIT growth

2.3%

6.6%

11.2%

4.9%

20.6%

23.8%

13.9%

17.0%

Personnel improvement

-0.5%

-0.2%

-0.4%

-0.5%

-0.5%

-0.5%

-0.5%

-0.5%

Personnel / Net revenue

43.2%

43.0%

42.6%

42.1%

41.6%

41.1%

40.6%

40.0%

Other SG&A / Net Revenue

14.4%

14.5%

14.9%

14.5%

14.5%

14.5%

14.5%

14.5%

EBIT / Net Revenue

42.3%

42.4%

42.4%

43.4%

43.9%

44.4%

44.9%

45.5%

Reverse DCF:

Discounted Cash Flow Analysis

In Millions of USD

2012

2013

2014

2015

2016

2017 (TY)

Operating Cash

409

468

590

675

795

Capital Expenditures

(57)

(65)

(76)

(84)

(94)

Free Cash Flows to Equity

351

403

514

591

700

728

$12,136

Cost of Equity

10.0%

Terminal Growth Rate

4.0%

Calculation of Value per Share (in million)

NPV of FCFE for years 2013-2015

1,714

+NPV of Terminal Value

8,289

Equity Value of CHRW

10,003

Divided by # of shrs o/s at 12/31/2012

165

=Value per share

$61

NTM P/E:

(click to enlarge)

Bottom Line

With forward P/E (20x) trading near 2009 level, Robinson could be a great buy if current market is cyclical and there is mean reversion in the next few years. The secular pressure of expensive truckload capacity and shippers keeping a low inventory level and high inventory turn will limit the extent of any unplanned freight in the spot market and set a new level for a normal net revenue margin. Intermodal is taking share from truckload. Gross revenue growth is driven by expanding existing contractual relationships with existing shippers. The administrative heavy nature of freight forwarding would put pressure on SG&A leverage. Mid-sized truckload brokers are competitive threats. The company is paying up to enter the ocean and air market, which are struggling with excess capacity. The low capital intensity and brokerage penetration are positives. However, the headwinds will put pressure on return on invested capital and free cash flow in the out years. Bottom line, you are already paying for the company returning to a high-teen net revenue growth and continued operating leverage for the next four years. There is downside risk with little margin of error.

Source: Does C.H. Robinson Have A Moat?