C.H. Robinson earnings victimized by higher rates

CH Robinson

Large 3PL sees margin compression despite rise in volume, missing Wall Street earnings estimates

Rising spot pricing is good for carriers operating in that market, but there has been some past evidence that it may not be quite so good for third-party logistics providers (3PLs) that rely on spot capacity to secure capacity to meet their contracted loads. The latest evidence came out late yesterday when C.H. Robinson reported its second quarter earnings, badly missing Wall Street expectations.

C.H. Robinson reported a 22% decline in year-over-year EPS at $0.78 vs. estimates of $0.90. The company reported $1.00 EPS in the second quarter of 2016. Based on a Stifel analysis of the earnings report, the company’s truck brokerage business significantly impacted earnings.

Morgan Stanley analysts said that net revenue was the main culprit for the company’s earnings miss. Net revenues were $574mm vs. Morgan Stanley estimates of $609mm.

C.H. Robinson stock is down more than 5% in mid-day trading to $64.87 a share.

“Selling long to shippers while buying short from carriers always has had the potential to squeeze margins, but this quarter, the phenomenon wreaked havoc with the company’s profitability,” the Stifel analysis said. “Net revenue margins fell 250 basis points y/y to 15.5% in the quarter as the company was not able to adjust contract rates quickly enough to compensate for the severe tightening of truckload supply and subsequent demand which was evident in the 2Q17. Operating margins fell even more dramatically (i.e., 760 basis points y/y) to 31.7% as the company continued to build its technology platform and continued to build headcount in the pursuit of additional market share and a more defensible strategic position.”

In its North American truckload segment, unit pricing remained flat year-over-year, but transportation costs rose 4%. C.H. Robinson did report an 8% year-over-year increase in truckload brokerage volume. The Stifel report noted that while Robinson does not typically report the amount of freight that moves on contract, it is believed to be between 50% and 75% of freight volume. With shippers not yet accepting contract rate increases, despite van spot rates rising to levels not seen in years – they were up to $1.90 per mile at the beginning of this month, according to DAT – large 3PLs like C.H. Robinson are facing greater exposure to margin compression.

“It will probably take a more severe and protracted tightening of supply and demand before some meaningful pricing relief from customers is available,” Stifel noted.

Even though spot rates across the board dropped last week, it is probably not enough to ease the pressure brokers are feeling in their bottom line, which continues to suffer due to the higher rates.

“The recent reports in brokerage margins should not come as much of a surprise had you been paying attention to the contract rates vs. the spot rates,” Craig Fuller, CEO and Managing Director of TransRisk, said. “Large 3PLs such as CH Robinson lock in forward prices for shippers and have to buy trucks on the spot market when it comes time to deliver against those agreements. If the contract rates are not appreciating (which they are not) and spot rates are going up - you get margin compression. This will be consistent for any 3PL that operates in the forward market.”

TransRisk is building tools to help brokers as well as shippers and carriers manage this exposure more effectively through actionable data, real-time market information, and tradeable financial futures contracts that lock in pricing.

C.H. Robinson did report better news in it LTL brokerage, which still saw net margins decline but not as much. LTL volume grew 6.5% in the second quarter over 2016 and intermodal was up 15.5% year-over-year on flat pricing and compressed revenue margins, Stifel said.

Still, there is not enough good news in the report to keep analysts’ enthusiasm. Stifel lowered its forecast for the firm, dropping its three-year EPS estimates to $3.30, $3.60 and $3.95 for 2017, 2018 and 2019. Those are down from $3.50, $3.80 and $4.15 respectively.

Morgan Stanley’s analysts believe that continued squeezing of margins and the company’s tradition of honoring contracts indicates that a quick fix is not imminent.  

“We believe CHRW’s ability to raise contract prices could be further complicated by secular competitive threats now that Uber, Amazon and startups are trying to establish a toe-hold in the marketplace,” Morgan Stanley said. “The good news is that C.H. Robinson continues to take share and grow very fast - the bad news is that this comes at the cost of price/margin. Given the growth rate, we would have expected more leverage on fixed costs but operational margins missed us as well, as headcount grew about 8.1% y/y vs. revenue growth of about 12.4%.”

According to Fuller, the contract vs. spot price trend that so negatively impacted C.H. Robinson may be part of a larger trend that is changing the dynamic.

“Historically, we have seen contract rates go up when there is pressure on spot rates,” he said. “That does not appear to be the case this cycle - which suggests something is different this time around. The view I have is that with digitization and the fact that shippers have so many choices available to them to secure capacity, they are unlikely to run out of capacity and have freight left on their dock - i.e. they can buy a truck at a price, but don't have to change their contract prices to do this.

“With smartphones and digitization taking place, shippers can access an almost endless supply of capacity,” Fuller adds. “They will ride out the peaks in demand by paying higher spot prices while enjoying low contract prices. It is only once the larger carriers start pulling freight away from contract customers and put it into the spot market that we will see a fundamental change in pricing in the contract market.”

The result is that carriers have a choice to “take freight at marginable rates in the contract market or expose more capacity to the spot,” Fuller noted. “Without a futures market – it’s a risky move; what if you are wrong and the spot market doesn’t hold up? That is dangerous.”

It’s a game that large 3PLs have been playing for years, and earnings may not be starting to reflect that.