The railroads tell us a lot about the economy. They also point us to stocks likely to produce upside. Over the past two years, rail volumes have been an excellent proxy for economic expansion. In fact, volumes have improved in all but one month since June 2009. Volumes are not only keeping investors focused on commodity stocks, but on logistics stocks as well. One such freight company is Hub Group (NASDAQ:HUBG), which derives 70% of its revenue from intermodal freight marketing.
HUBG is a 40-year-old freight company and one of the biggest players in intermodal freight. It’s Union Pacific’s (NYSE:UNP) largest intermodal relationship and the second-largest player on Norfolk Southern’s (NYSE:NSC) lines. Its services combine short haul trucking with long haul rail, saving both time and money. Overall, intermodal volumes are growing more rapidly than overall carloads, suggesting additional upside for HUBG.
In 2010, U.S. rail carload volumes rose 7.3% from 2009, while intermodal volumes were up 14.2%. In February, intermodal rail volume was 10.3% higher than February 2010 and 21.4% above February 2009. In the most recently reported week, the Association of American Railroads says intermodal volumes were 5.7% higher year-over-year. Typically, intermodal volumes peak in Q3, suggesting Q2 is the perfect time to be buying shares in HUBG.
HUBG’s Q4 results reflected the strengthening intermodal market. Total revenue rose 18% year-over-year, led by 19% growth in intermodal sales; intermodal revenue strength came from both higher volume and better pricing, rising 14% and 4%, respectively. Overall, Q4 marked the fourth consecutive quarter of double-digit intermodal sales growth for the company. With 1700 drivers, plans to add 300 more this year and expanding midwest operations, HUBG is on track to grow again this year.
Retail inventory building is a key to HUBG’s intermodal success, accounting for a third of HUBG’s intermodal business. Better retail inventory turns, sparked by rebounding consumer spending and solid holiday retail sales, are increasing freight shipments. Last quarter, business from retailers grew 30% from the prior year. Consumer products and durable goods also drive intermodal revenue, and while durable orders stumbled in February, consumer spending has increased for eight consecutive months, rising 0.3% in February from January after adjusting for inflation. Overall, retail sales from November through February were up 8.9% year-over-year, according to the Department of Commerce. This suggests HUBG will see another quarter of strength when it reports its Q1 results.
HUBG’s growth opportunities aren’t solely intermodal. The company also stands to benefit from overall market growth in logistics. Shippers are increasingly turning to third party experts for freight management, relying on firms to consolidate shipments and manage pricing. As a result, HUBG’s Unyson Logisitics revenue rose 38% to $61 million last quarter, bringing the segment to about 12% of total revenue.
And its trucking brokerage revenue, which was flat last quarter year-over-year, offers upside too. While trucking brokerage revenue was anemic last quarter, the company was able to get its margins back on track in the second half of last year. As a result, the company’s gross operating margin was 200 bps better than Q4 2009, rising to 4% from 3.8%, with margin upside potential given gross operating margins peaked in ’07 and ’08 around 5%.
The company’s asset-light approach, using leases and contracting with owner operators, makes its balance sheet shareholder-friendly. The company doesn’t have any debt and has $115 million in cash for acquisitions and buybacks.
HUBG’s client base is diversified, with no customer accounting for more than 6% of revenue. While its name is well-known in the industry, there’s a lot of market share upside. Currently, only about one in three of the nation's shippers use its services.
HUBG is a great play on rising rail volumes, specifically for fast-growing intermodal activity, offering investors a nice balance sheet and solid earnings upside. Even at the recession’s worst, the company posted $0.91 per share in 2009. This year, earnings are expected to be up 34% to $1.56 per share. In 2012, they’re expected to rise another 22% to $1.91. Yet short sellers remain unconvinced, holding 6.3 days to cover worth of shares short. That means potential upside from covering, as intermodal volumes remain strong – giving one more reason for investors to be long.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HUBG over the next 72 hours.