C.H. Robinson's operating margins get squeezed, and Wall Street notices...and reacts

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It had already been signaled that analysts were going to be throwing some pointed questions at the management of 3PL company C.H. Robinson on its Wednesday earnings call, after a late Tuesday release of its earnings showed a decline in the company’s operating margin during a quarter in which so many other transportation companies were reporting robust numbers.

“Effectively very strong gross revenue growth of +14.9% (which also drives costs) was offset by higher purchased transportation costs, driving lower net revenue margin and much lower operating leverage” is how Deutche Bank analyst Amit Mehrotra said in an investor’s note. “Net/net we’d expect shares to be down in (Wednesday’s) trading (up to 5%), reflecting the operational miss,” a reference to what Mehrotra said was a $7 million miss in projected operating income. And at the close of trading for the day, C.H. Robinson’s shares were down $7.75 to $82.90, a drop of 8.54%.

The first questions taken by the Robinson management were all about operating margin, which declined 250 basis points to 30.6%. On the Robinson call, questions are sent in advance, so there was no chance for a follow-up. Still, three analysts sent in questions about the operating margin issue and how the company posted not only lower margins but also only an approximately 2% increase in operating income, a very small number in such a strong freight market.

C.H. Robinson chairman and CEO John Wiehoff, in response, said the company has always looked at net revenue growth and operating income separately. And the company did grow net revenues by 10.1%, to $625.9 million. “Our goal has been, and remains that we believe we can grow our net revenue and our operating income at similar rates,” Wiehoff said according to a transcript of the earnings call provided by SeekingAlpha. Freightwaves also listened to the call.

As to the operating income, Wiehoff noted that last year’s number was impacted by a legal settlement. Taking that out of the equation, Wiehoff said the company grew operating income 6%-7% in the first quarter of this year.  But he also conceded that overall, the financial report reflected a place that is “not where we want to be long-term.”

Robinson’s North American Surface Transportation group (NAST) saw an 11.7% increase in operating income. It had approximately $2.6 billion in revenue. The far smaller Global Forwarding and Robinson Fresh divisions, both with revenue of about $550 million, showed declines in operating income of almost 50% for Forwarding, and 36.5% for Fresh.

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Transportation anayst Bascome Majors of Susquehanna Financial noted that the poor performance of those two smaller groups is not new; Fresh has had “seven straight quarters of deterioration.” Given that, “we see a downward re-basing of both buy side and sell side expectations primarily driving today's weakness, with some piling on from a lower-than expected Y/Y uptick in gross revenues into early 2Q (April-TD up 11% vs. 1Q +10%),” he wrote in a report issued after the earnings call. Although the April numbers were not in the quarterly report, they were mentioned during the conference. 

COO Robert Biesterfeld, in the call before questions were taken, boasted of the company’s net revenue margin for all services. He showed a graph that illustrated percentage changes in Robinson’s truckload rate and the cost per mile to customers and carriers. It showed that they have tracked at a close to perfect correlation. “You can also see that despite the high level of volatility in the freight market, we are able to maintain our margins through these extended freight cycles,” Biesterfield said. “Our first quarter transportation net revenue margin of 16.4% is up slightly versus the same period five years ago and our annual net revenue has increased over $650 million during this five-year time period.”

Earlier in the call, Wiehoff issued a lament that has become familiar this earnings season with asset-light 3PL companies that have needed to venture into the red-hot spot market for capacity to fill contractual obligations. “Rapidly rising prices typically create incremental spot market activity and margin compression on committed pricing arrangements,” he said. “We experienced both of these in our first quarter results.”

More to the point, Wiehoff said: “If you look at our largest source of revenue being a mid-teens margin business that we source daily in the spot market, and those cost went up 21%, we had to re-earn and recommit to well over half of our portfolio in a very active marketplace.”

The earnings report spelled out how tough it was for the company on the expense side of the ledger. All operating expenses were up 14.1%. Personnel expenses were up 13%, fueled by a 5.7% jump in headcount and expenses that went along with that. SG&A was up 17.7%, though those numbers included the impact of the year-earlier settlement.

Truckload volumes for C.H. Robinson declined 7% in the quarter. That brought an analyst question, and COO Bob Biesterfeld said most of the decline was in contractual volumes, with the spot market business for the company growing double digits. That’s the sort of shift that squeezes margins, because contracted business at more moderate pricing gets eclipsed by higher spot business; “We do see this happen typically in periods of rising rates where that portfolio tends to shift a little bit,” Biesterfield said. He added that the decline in contracted truckload is expected to snap back. .

The conditions that lead to such a margin squeeze were at the heart of a debate discussed on the call: what are the tradeoffs between volumes and margins, and can too much volume be chased that ends up not being profitable?

Wiehoff said the current price increases are sticking around for 2018 and pricing will need to deal with that. “Some of the repricing that occurred last year has proven to be inadequate, and some of the pricing that we're applying in the marketplace today is not being accepted by those shippers who are trying to take a different approach in terms of how they route their freight,” he said. There isn’t one solution, Wiehoff said, but the fact that there are those tradeoffs “just becomes a byproduct of how we enter into each bid arrangement and the results of each of those shipper interactions.”

With contracted prices running well behind spot rates, Biesterfeld, in response to an analyst question, said a normal marketplace would have about 80-85% in contracted arrangements, and the rest in “transactional,” or spot. At the corresponding period of 2017, when “spot rates really lagged contractual rates,” shippers would keep demand away from the contract market to capitalize on spot rates.

The reverse is now true, Biesterfeld said. Much of the contract business are at rates that “don’t necessarily hold up in rising markets” and ends up being tendered “in a secondary market of some sort,” where rates would be tied more to spot levels. “So I don't know that shippers necessarily plan in this environment to have more freight enter the spot market,” he said. “The freight that goes into the spot is typically more of an outcome of a plan that maybe didn't execute at the level that was planned for.”