Description

Company Overview

CH Robinson (CHRW) is the leading freight logistics brokerage firm in the US w/$28B in gross bookings, 100K shippers and 85L carriers moving 20mm shipments.  The company’s primary segment is its North American Surface Transportation (NAST), which covers truckload (TL) (40% of sales) and less than truckload (LTL) (20% of sales) which accounts for a combined ~60% of its revenues and gross profits (down from >90% pre-COVID).  Its Global Forwarding segment accounts for ~35% of sales (up from <20% pre-COVID) and includes its brokerage of ocean (>20% of sales), air (HSD% of sales), customs (LSD% of sales).  Its other segment has some sourcing and other services that are another ~5% of sales.  CHRW typically buys capacity from carriers on the spot market and sells capacity to shippers on a mix of spot and contracted basis.

Thesis Overview

CHRW is overearning across all its segments, and while the street is aware of the overearning in the NAST business, we see even further and more hidden overearning in the Global Forwarding business off COVID-driven price spikes which now accounts for almost ½ of EBIT vs. <15% pre-COVID).  Street appears to be just waking up to this dynamic now but underappreciating the reversion.  As rates come down from normalization in supply chains and lower consumer demand, we see normalized earnings of ~$4.50, ~30% below Street estimates and think the stock is worth low-$70s on the reversion alone + potential to be mid-$60s w/volume declines in a recession, for a >30% return.

Forwarding Business is Massively Overearning

Forwarding consists mainly of Ocean and Air freight forwarding (>75%) and also includes Customs and Other brokerage (<25%).  Pre-COVID, this business was <20% of sales and EBIT, but as of LTM 6/22, it was 35% of sales and almost 50% of EBIT.  Per the below, the spike in Net Revenues (gross revs less purchased transportation) was driven by a huge spike in Ocean and Air prices + volumes.  In addition, multimodal volumes drove incremental margin uplift.

CH’s Ocean Freight Business is Overearning

-          Ocean freight prices increased from ~$1,500 / container to >$10K, with some spot rates reaching >$20K per some VAR contacts

-          The normalization in ocean freights is well underway, with benchmark rates breaching through $4K level and some shipping contacts told us they saw rates come in below $3K

-          Despite the material y/y rate declines (76)% y/y, ocean freight rates remain >125% above pre-COVID levels

-          As supply chains are normalizing, port congestion wanes and inventories normalize with softening consumer demand, we expect rates to approach pre-COVID levels, as we are already seeing imports decline

Air Freight is Also Materially Overearning

-          Air freight didn’t experience the same level of rate increases, but rates still remain >100% above pre-COVID levels → we wouldn’t expect a full normalization given jet fuel prices remain ~30% above pre-COVID levels

-          Here, the tightness was driven by emergency PPE shipments from Asia followed by the massive demands for vaccine shipments to vaccinate the world from COVID in addition to spillover demand from delays due to ocean freight disruptions

o   Per IATA: “Vaccine deliveries and PPE shipments, typically carried by air, further contributed to the outperformance of air cargo and to the improvement in growth seen in December amid the spread of Omicron.”

-          In addition the rate issue, our checks reveal that CHRW won additional share as a result of a cybersecurity breach at Expeditors (EXPD), which has started to win back volumes

Similar to ocean freight, we’re seeing we’re seeing a softening of air cargo demand, particularly as we’re lapping the vaccine shipments

If rate normalization were the end, it would be an annoying headwind they’d need to overcome.  However, multiple checks have said that CHRW won incremental multimodal brokerage volumes (i.e. moving from ocean or air to truck) which can boost margins from mid-teens to mid-twenties or higher in aggregate. 

As a result, we expect demand normalization to reverse this margin uplift, pressure margins to revert to the longer term average in the high-teens vs. the street which appears to blissfully assume that BOTH Forwarding revenues will remain elevated and margins will remain >30%.

 NAST Spread Reversion

NAST is the more followed business line given it has accounted for ~2/3 of the sales and ~90% of the EBIT (pre-COVID) though only ~55% of LTM EBIT.  The overearning / normalization here is somewhat better understood.  This overearning is similar to what yarak775 pointed out several years ago, though the spot vs. contract spread of ~70c is currently 2x what they were back then.

-          CHRW has benefited from a large spread between contract and spot rates over the past several months, and conversations have been happening real-time to reduce contract rates in light of the massive disparity vs. current spot rates. 

o   The last time spreads were so wide was late 2018, after which they collapsed, and the stock was down 20% (underperforming the SPX by 30%) over ~12 months…  and then COVID happened

-          As contract rates revert towards spot rates, we expect margins to normalize to the mid-30% vs. the >40%+ in 1H22, below 2017-19 levels as more players have entered the market and introduced new competition.

-          We also see companies like XPO taking a greater share of the brokerage market with their investments in technology, as they have materially outgrown the market as incremental pressure

Valuation

The ocean and air rate declines should draw more focus as NAST overearning runs out of steam as contract prices converge w/spot rates and excess spreads unwind.  We are well below Street on both EBITDA ~$850mm (~27% below Street’s $1.16B) and EPS ~$4.50 vs. (~30% below Street at ~$6.40).  Absent a recession, at ~17x EPS or ~11x EBITDA, we think the stock is worth somewhere in the low $70s but see further downside to volumes and pricing and think it's closer to ~$65 vs. the bulls who have targets of $115+.

Even if NAST is able to maintain higher profitability in the 40% range vs. our 35%, from technology changes etc., the Forwarding collapse will still keep a lid on the stock as #s continue to come down.

Other thoughts

We don’t see material upside from activism and are suspect of the purported sale of the Forwarding business, certainly at the rumored $9B valuation in the press this summer.  While we have no insight into the deal, a European buyer with depressed currency, tight financing markets using a healthy multiple on peak earnings seems like a fallacy.  

Catalyst

Earnings; bullish sellside #s and P/T come down