CH Robinson (NASDAQ:CHRW) is a transportation broker. It connects a network of shippers to a network of mostly independent freight carriers. The company posted 2012 net revenue of $1.72 billion with approximately 75% from trucking (both full-load and less-than-truckload). 2012 EBITDA was $713 million, producing a 41.51% EBITDA margin (net). Margins at CHRW have been impressively consistent at 44.50% every year since 2009. While margins are presently below historical average, this is due to a recent acquisition and the temporary effect of economic cycles on CHRW's business as detailed below. CHRW's consistent cash flow enabled substantial dividends and buybacks in each of the past ten years, with 2012 dividends of $275 million ($1.70/share) and buybacks of $256 million ($1.58/share).
Truck transportation is a highly fragmented industry. The top 15 trucking companies by revenue account for less than 6% of total market share. The vast majority of truck transportation revenue is collected by independent truckers and small firms, because the barriers to entry are as low as the qualifications to get a bank loan and obtain a commercial driver's license. When considering an investment in an asset-based trucking company like Marten (NASDAQ:MRTN), Old Dominion (NASDAQ:ODFL), or Knight Transportation (NYSE:KNX), industry fragmentation and the resulting lack of economic moat detracts from an otherwise attractive value proposition. Rather than fighting fragmentation as a headwind, investors should consider making it a tailwind and investing in an enterprise that benefits from fragmentation - transportation brokers.
Brokers like CHRW benefit from both sides of the trucking industry's fragmentation. On the demand side, CHRW connects small and medium sized shippers with a nationwide network of transportation firms capable of serving each shipper's unique requirements (size, reliability, speed, etc). Outsourcing shipping logistics to a third-part broker reduces shipper expenses and eliminates the IT investment necessary to coordinate a complex logistics network. Logistics outsourcing is a growing trend as global shipping needs overwhelm the internal capabilities of small and medium sized shippers and the benefits of third-party alternatives becomes more pronounced. Indeed, CHRW's logistics services segment increased profits by 26% in 2012. Further, CHRW is able to negotiate more favorable shipping rates or combine less-than-truckload (NYSEARCA:LTL) shipments to improve efficiency. On the supply side, CHRW offers consistent freight to trucking firms who must otherwise sell their capacity themselves. Additionally, truckers often contract for one-way freight hauls. If they are unable to secure a return freight contract, they may rely on CHRW to provide a return load and reduce the truck's non-revenue mileage. As a result, CHRW can improve pricing on both the demand and supply side of the transportation industry and provides a compelling value proposition for both shippers and carriers.
Brokers like CHRW are distinct from asset-based transportation companies because of their non-asset business model. CHRW operates 189 branches in the United States and 87 internationally, primarily in Europe. The offices are allowed significant autonomy and find their own business opportunities. Branch manager compensation is tied to branch performance, growth, and other branch-specific metrics. The marginal investment needed to open an additional office is negligible - IT investment and a lease - so the resulting business is highly scalable. Unlike asset-based truckers that have a fixed cost structure, brokers operate on a variable cost structure that protects them during economic downturns. CHRW's primary expense is compensation and its account managers are paid entirely on commission, so compensation expenses decrease naturally in a recessionary macro environment. While investors are surrendering upside, they should note CHRW actually posted a slight EPS improvement from 2008-2009, a period where most asset-based truckers took significant losses. The consistent margins of the variable cost structure combined with the low reinvestment needs of the non-asset model preserve CHRW's ability to generate consistent cash flow, funding dividends and buybacks that are hard to ignore.
Brokers and asset-based carriers operate in three phases of the economic cycle, but they behave differently in each phase. In the boom phase, demand for trucks exceeds supply of trucking capacity. During the boom, non-asset brokers benefit from market disequilibrium by charging a premium to connect shippers with trucking capacity that may be scarce. Revenue improves, but higher trucking costs and compensation mitigate margin expansion. Asset-based carriers, in contrast, react to economic booms by adding additional capacity, investing in new trucks, and funding dividends/buybacks. Revenue growth from pricing power boosts margins and EPS, but cash flow is split between capital returns and reinvestment. During a recession, carrier revenue declines in lockstep with economic activity and oversupply from capacity additions during the boom phase compound the decline in carrier pricing power. Margins collapse as declining revenues meet a fixed cost structure and EPS often goes negative. Non-asset brokers actually benefit during the bust, with reduced demand for transportation offset by declines in prices charged by carriers.
That, combined with the variable cost structure, preserves margins, cash flows, and healthy capital returns. Brokers benefit least from the middle phase where supply and demand are in equilibrium. With no shortage or surplus to provide pricing power, brokers see their margins compress even as volumes begin to recover. Asset-based truckers fare better between cycles because they begin to generate positive operating leverage without requiring new capital investment, preserving their financial flexibility. In sum, asset-based truckers ride the waves of the economic cycle - outperforming and spending heavily in good times only to underperform in recessions. Non-asset brokers outperform anytime the market is out of equilibrium - boom or recession - and underperform in the economic trough, where supply and demand for transportation reach equilibrium.
A primary catalyst for CHRW over the next year will be the Federal Motor Carrier Safety Administration's upcoming hours-of-service restrictions for truckers set to take effect July 1, 2013. The FMCSA's upcoming rule change modifies how long a truck driver can operate without a rest break. It also imposes substantial restriction on the "34-hour restart" used by drivers to restart their hours-of-service clock. The net effect of the hours of service restrictions is to reduce trucking capacity by 5%-10% - a level that would require hiring 100,000 additional truckers into an industry already facing a shortage of qualified drivers. As explained above, brokers benefit when markets are out of equilibrium. Asset-based truckers may see monthly revenue-miles fall, but brokers will benefit from connecting shippers to scarce capacity. Further, large brokers like CHRW have the capability to monitor carrier hours-of-service and reliability, selecting only those carriers who are suitable for a customer's needs. Reliability is more important than cost for specialized shippers of critical or perishable goods, creating an opportunity for CHRW to help shippers navigate the coming shortage of trucking capacity.
The low-investment, variable cost model of non-asset brokers compares favorably to the high-investment, fixed cost model of asset-based carriers across economic cycles. I recommend CHRW versus other brokers because I believe its size and scale confer significant economic advantages, creates a network effect, and enables investment in new technology. While trucking is a fragmented industry, there are also hundreds or even thousands of small, independent brokers operating in the United States. CHRW is the largest by far, with 20% market share on a revenue basis and much larger than its next closest competitor - Hub Group (NASDAQ:HUBG) with 8% share. CHRW's 276 offices are found in all 50 states (69%), with 51 offices in Europe (18%), 31 in Asia (11%), and 4 in South America (2%). The scale of CHRW's branch network offers more consistent freight for carriers and offers shippers access to tens of thousands of qualified carriers - more than most other brokers. CHRW has the cash flow to invest in IT projects and they've developed a software platform to integrate and coordinate assignments across their entire network with precise detail. With new IT initiatives like app-based mobile connections to truckers improves reliability and tracking. Navisphere, CHRW's supply-chain coordination software for shipping customers and provides a moat to encourage retention of global shipping customers. As logistics outsourcing becomes more common, CHRW's IT capabilities could be its biggest advantage versus smaller brokers.
A DCF valuation using constant margins, consensus revenue growth, an 8.00% cost of capital and a 2.50% terminal growth rate yields intrinsic value for CHRW's shares of approximately $70. In a bullish scenario where margins expand due to disequilibrium in the transportation market, CHRW's fair value improves to $75 per share. The current market price is approximately $55, with capital returns (dividends + buybacks - new issues) yielding 5.75% in 2012 and appearing reasonably secure.
Investors seeking to invest in truck transportation should consider avoiding asset-based truckers and buying CHRW, a broker with strong long-term prospects, leading market share, secure cash flow, capital returns, and 25%-35% upside in shares.