J.B. Hunt: Does Cheap Fuel Help Or Hurt It? The Answer May Surprise You

| About: J.B. Hunt (JBHT)
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Summary

Intuition says cheap fuel = better profits.

But JBHT charges what looks like a very lucrative fuel surcharge much higher than fuel costs and risks losing the profitable spread between the two.

So which is it? It helps or doesn’t help? The definitive answer I found on how it all works surprised me and may surprise you too.

Let me walk you through my research and thinking on J.B. Hunt (NASDAQ:JBHT) real quick because it's kind of funny and will help you understand how I arrived at the conclusion I came to. First my thinking was to study the trucking industry all over again (it's been a few years) with the thought being cheap means higher profit margins. There has been a multi-year shortage in drivers available which has helped margins remain healthy for those with drivers. The reason I recall the ongoing shortage in drivers is because workers tend to be inelastic to compensation increases so the supply shortage is ongoing as the trucking industry doesn't budge much in terms of attracting new people in with higher pay. It's just not practical for them. So I'm thinking go long JBHT.

My thought process was that cheaper fuel will just add greater to the bottom line. So I went through every quarterly report going back 8 years to look at fuel surcharge revenue and fuel costs. Much to my amazement, these two amounts have had a very significant spread -- often the difference between the two equal to the entire operating income for the quarter! Now I'm thinking cheap fuel would be bad for JBHT because it would be harder to justify these seemingly lofty fuel surcharges that seem quite lucrative while JBHT basically breaks even on operating revenue -- which has been around 88% the total overall revenue. Now I've changed my mind and I'm thinking go short JBHT.

Next, using the theory that declining fuel prices means less profits for JBHT, I went to the last time there was a severe crash in fuel prices which was the second half of 2008. Low and behold and much to my confusion, the spread between the fuel surcharges and the fuel costs actually increased much more profitably in the second half of 2008 all the diesel and oil prices were imploding. What's going on here? Then I took another look at the first half of 2009 when energy prices made a dramatic recovery noticed once again the surcharge/cost ratio was worse than ever or basically break-even. How could this be?

The 10K filing came to the confusion rescue. First, I found this blurb in there,

"It is not meaningful to compare the amount of fuel surcharge revenue or the change in fuel surcharge revenue between reporting periods to fuel and fuel taxes expense, or the change of fuel expense between periods, as a significant portion of fuel cost is included in our payments to railroads, dray carriers and other third parties. These payments are classified as purchased transportation expense."

I then thought to myself, jeez, I did all this research for nothing and it was just a misunderstanding of how the surcharge/fuel cost spread works. But that didn't make sense either because looking again at the periods the rise and fall of fuel costs if plotted on a chart the costs of fuel seem to have correlated very well with the volatility of oil prices. Next I found this blurb in the 10K that explains it all, my emphasis added,

"We have fuel surcharge programs in place with the majority of our customers. These programs typically involve a specified computation based on the change in national, regional or local fuel prices. While these programs may adjust fuel cost changes as frequently as weekly, most also reflect a specified miles-per-gallon factor and require a certain minimum change in fuel costs to trigger a change in fuel surcharge revenue. As a result, some of these programs have a time lag between when fuel costs change and when this change is reflected in revenues. Due to these programs, this lag negatively impacts operating income in times of rapidly increasing fuel costs and positively impacts operating income when fuel costs decrease rapidly."

Unless you've been living in a cave, you've probably noticed that fuel costs have decreased the most rapidly in this current quarter than we've seen since 2008 - the last time JBHT also saw a huge jump in the surcharge/cost spread. While the first blurb in the 10K is correct that this spread doesn't change evenly, the second blurb explains that it doesn't change evenly because the cost side sees an immediate benefit to JBHT when fuel prices drop rapidly but the corresponding fuel surcharge revenue doesn't lags behind and brings extra profit to JBHT.

Keeping all this in mind, analysts have not budged their Q4 2014 EPS estimates for at least the last 60 days even while fuel prices have basically collapsed. My conclusion: Either analysts are going to raise JBHT's earnings estimates or the earnings results may have a surprise beat. If you study the numbers of last quarter as an example, JBHT had $115 million in fuel expenses and a pretax bottom line of $165.5 million. It doesn't take much of an improvement of the surcharge/fuel cost spread to add materially to the bottom line yet analysts aren't expecting Q4 to be much different than Q3. The average estimate is at $0.89 but there is one guy at $0.97. Maybe he's seeing what I'm seeing. JBHT should report in about a month, and I will likely buy some shares just ahead of the report if not sooner.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.