Investors Still Paying Up For J.B. Hunt's Uncommon Growth Prospects

By Stephen D. Simpson, CFA | October 12, 2012 AAA

Once again I find myself in a familiar place with J.B. Hunt (Nasdaq:JBHT). I like this growing intermodal services provider, and I do believe it's one of the most compelling organic growth stories in the transportation sector. On the other hand, I don't like how growth-starved investors have bid up the shares of this company to a level where I believe outperformance could prove difficult.

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Another Spotty Quarter, but Better than Feared
For the second quarter in a row, J.B. Hunt delivered results that required some explanation. Typically that's a dangerous thing for a stock that carries a premium valuation to its group, but this time it seems like there's more of a relief that results came in as they did. Revenue rose more than 10%, which was helped by strong growth in the small Integrated Capacity Solutions (ICS) business (up 30%) and ongoing solid performance in intermodal was up 15%. Dedicated Contract Services (DCS) squeaked out a little growth (up 1%), while the company's truck operations saw a 9% drop.

Expense control and profitability weren't bad this quarter. Purchased transportation was the only major expense item to outgrow revenue, and operating income rose 12% overall (with a further 60 basis points improvement in operating margin). Although profits were slightly short of estimates, it was due to higher expenses in trucking (operating income down 41%), as intermodal profits rose 25%. Given that trucking isn't a big part of the company's future, analysts and investors will likely give a pass to this miss.

Core Fundamentals a Little Mixed in Intermodal
J.B. Hunt's intermodal operations continue to grow pretty nicely, albeit maybe not perfectly. Loads rose 15% this quarter, marking a nice little pick-up from the first quarter, as pricing was flat. The company has added more backhaul traffic, which is good for margins but hurts yields. All in all, though, I'd say this isn't a bad result, and the shares of fellow intermodal/brokerage services provider Hub Group (Nasdaq:HUBG) also reacted positively to the news. I still see no reason not to expect good things from this business for a while yet. The company is still heavily dependent upon Berkshire Hathaway's (NYSE:BRK.A, BRK.B) Burlington Northern for intermodal volume, but Norfolk Southern (NYSE:NSC) is growing as a customer and adding intermodal yards. What's more, with the very uncertain future of coal it seems fair to assume intermodal will remain a major focus for Class 1 rails.

Trucking Still not Very Good
J.B. Hunt's trucking operations are still dragging on results. Fleet sizes fell 9% this quarter, with revenue per tractor down more than 2%. I'm wondering if the company is starting to see dis-economies of scale (operating income fell 41% this quarter). What's more, it wasn't like the DCS business was great either, as profits fell 14%. If there was a bright side, it was that pricing was better as rates per load mile improved about 6%. So, I'll be curious to see what other truckload carriers like Knight (NYSE:KNX) and Swift (NYSE:SWFT) have to say about their quarters - the higher pricing at J.B. Hunt was good news, but will they see the same weakness in volumes and higher costs? Either way, this isn't a business that's doing any favors for the company and I do wonder if management could do more to minimize the impact (like a sale or spin-off).

The Bottom Line
I'd love to get a chance to buy these shares at an attractive price, but that's not today. Even if I assume mid-to-high teens growth in free cash flow, the shares still seem overpriced. Likewise, a trailing EV/EBITDA multiple above 10 times just seems too high to me - even for a quality organic growth story like this. As a result, I'd probably rather own a rail stock or less-than-truckload carrier like Old Dominion (Nasdaq:ODFL) today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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