Done right, asset-light transportation/logistics services can be quite lucrative even if the reported free cash flow margins are thin. As one of the larger players in intermodal (and the largest asset-light intermodal company), Hub Group (Nasdaq:HUBG) is taking advantage of the same intermodal growth trends that have been helping rival J.B. Hunt (Nasdaq:JBHT) and boosting the performances of Class 1 railroads such as Union Pacific (NYSE:UNP) and Norfolk Southern (NYSE:NSC). Although Hub Group is vulnerable to a further macroeconomic slowdown and a margin squeeze between rail carriers and customers, there could be worthwhile value in these shares.
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Third Quarter Results - Mostly Sunny, But With Some Clouds
All in all, Hub had a solid third quarter vis a vis sell-side expectations. Gross revenue rose 7% and just slightly beat expectations. Hub Group's subsidiary arrangement is a little convoluted, but Hub's intermodal operations saw roughly 11% growth in net revenue, while Mode (a subsidiary that also offers intermodal, brokerage and logistics services) saw only about 1% growth. Truck brokerage was up 6%, while logistics revenue rose 14%. While gross revenue was solid, margins saw some pressure. Net revenue rose 6%, but gross margin fell 15 basis points. Reported operating income did rise 14%, however, and just beat expectations.
Intermodal - Growth Is There, But Margins Could Be A Challenge
Due in large part to its cost efficiency, intermodal is taking more and more business away from truckload and less-than-truckload companies. With relationships with all of the Class 1 railroads, that gives Hub Group a good opportunity to grow. It's not quite that easy, though. For starters, Hub Group does not enjoy the same contracts that J.B. Hunt has with Berkshire Hathaway's (NYSE:BRK.A, BRK.B) Burlington Northern and Norfolk Southern, nor the same access to a large fleet of owned storage containers. It's also the case that Hub Group has somewhat limited pricing power - the rails have been raising their rates on intermodal carloads, and Hub can't always pass that fully on to customers. On the other side, the company is trying to handle more of its drayage in-house, and this should offer long-term margin leverage. To that end, volume rose 9% this quarter (with 13% growth in transcontinental), but pricing power was pretty limited. Relative to J.B. Hunt, there wasn't much difference in pricing, but J.B. Hunt saw stronger growth in the eastern region (22% versus 5%). With consumer and retail products making up a reasonably-high percentage of Hub's traffic, there could be some risk to volume if economic conditions worsen.
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Truck Brokerage Reverses Course
Although intermodal is grabbing share from trucking, it is not as though trucking has disappeared. Hub saw 6% revenue growth in truck brokerage this quarter, with volumes up 13% (reversing two quarters of single-digit declines). As mentioned previously, margins were also pretty strong here this quarter.
The Bottom Line
The question I have about Hub Group isn't so much about whether it can outgrow other intermodal companies such as J.B. Hunt or other truck brokerage companies such as C.H. Robinson (Nasdaq:CHRW) and Landstar (Nasdaq:LSTR), but rather whether the company can produce similar returns on capital and free cash flow (FCF). That's not to say that Hub Group is doing a bad job by any means, rather just a question as to how much more the company can improve. If Hub Group can improve its free cash flow conversion to a mid-single-digit rate and enjoy the same sort of mid-to-high single-digit revenue growth I see for J.B. Hunt, these shares could offer very good rewards from here. The shares also look relatively appealing on the basis of its EV/EBITDA ratio. Consequently, I think investors have an interesting dilemma choosing between J.B. Hunt and Hub Group - J.B. Hunt looks like the safer bet, but the valuation is more robust, while Hub Group could offer the greater upside with outperformance.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.