Hub Group, Inc. (NASDAQ:HUBG) Q3 2023 Earnings Call Transcript

Hub Group, Inc. (NASDAQ:HUBG) Q3 2023 Earnings Call Transcript October 26, 2023

Hub Group, Inc. misses on earnings expectations. Reported EPS is $0.97 EPS, expectations were $1.19.

Operator: Hello, and welcome to the Hub Group Third Quarter 2023 Earnings Conference Call. Phil Yeager, Hub’s President and CEO; Brian Alexander, Hub’s Chief Operating Officer and Geoff DeMartino, Hub’s CFO, are joining me on the call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Any forward-looking statements made during the course of the call or contained in the release represent the Company’s best good faith judgment as to what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate and project and variations of these words. Please review the cautionary statements in the release.

In addition, you should refer to the disclosures in the Company’s Form 10-K and other SEC filings regarding factors that could cause actual results to differ materially from those projected in these forward-looking statements. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host, Phil Yeager. You may now begin.

Phil Yeager: Good afternoon and thank you for joining Hub Group’s third quarter earnings call. Joining me today are Brian Alexander, Hub Group’s Chief Operating Officer, and Geoff DeMartino, our Chief Financial Officer. Over the past few years, we have transformed our earnings, returns and free cash flow profile through a clear strategy of organic investment into our core business while enhancing capital efficiency through technology deployment and accretive non-asset-based acquisitions. In ITS, we have created a less asset-intensive model that provides industry-leading service and value while becoming more efficient through enhancements to our drayage and dedicated operations. In logistics, we have built a service leading end-to-end solution for our customers that provides best-in-class scale and technology.

This evolution of our business has resulted in Hub Group being a more diversified and resilient company with an improved customer experience as well as significant free cash generation. Our operating model changes have proven effective as we have managed through this challenging freight cycle with a full year forecast that we expect will likely be our second best year in our Company’s 52 year history. With that performance in mind, and with the benefit of extensive feedback from our Board as well as existing and potential shareholders and equity analysts, we have taken the opportunity to reassess our capital deployment strategy. I’m excited to announce the results, which are also highlighted in the investor presentation which is available on our website.

First, we are establishing a long-term leverage target of 0.75x to 1.25x net debt-to-EBITDA. We are not in a rush to achieve this target and will do so methodically as we continue to invest in our core business, drove the acquisition and return capital to shareholders. Second, we have received authorization from our Board for a $250 million share repurchase program while retiring our current authorization, which had $83 million remaining. We believe this new and larger program demonstrates our commitment to returning capital to shareholders and the long-term value we see in Hub Group. Third, our Board has authorized a two for one share split that will be effectuated early in 2024 through a share dividend, which we believe will enhance liquidity in our stock and support long-term investment.

Last, in the first quarter of next year, we plan to begin paying a quarterly cash dividend equal to $0.50 per share annually on our new share account. The transformation of our business that I described earlier has provided us with the free cash flow and balance sheet profile that allows us to implement these four capital allocation initiatives, which will provide greater consistency regarding return of capital while allowing ample opportunity to continue to invest in our core business and execute on our acquisition strategy. Now, turning to the quarterly results and outlook. As we discussed on our last call, we felt as though the third quarter would be our most challenging and that did come to fruition. However, we saw improvement in demand throughout the quarter and increased tightness in the West Coast, indicating a need for some inventory replenishment.

However, peak season has been muted and we do not anticipate a sharp inflection in demand in the fourth quarter. Demand was soft through July and August, leading to volume declines in intermodal. Rail service has remained strong and we executed improved volumes per business day in September. While onboarding wins in shorter haul markets, we continue to focus on improving operations on the Street, reducing our cost to serve and maximizing the efficiency of our team. Although, we have made significant progress, we still have opportunity to improve operational fluidity and reduce costs. We believe there is considerable intermodal conversion opportunity in the upcoming bid season, and our commercial organization is focused on returning to growth.

Our rail partners have remained committed to providing a great service product, and we believe that the combination of quality service cost benefits versus truck and greenhouse gas emission reductions will lead to share gains from over the road and create improved balance and velocity in our network. Our logistics business performed well, once again illustrating the resiliency of our model. We executed well in brokerage, leading to share gains due to our strong service and value proposition, while driving new wins in organic expansion in our warehousing, managed transportation and final mile services. Our pipeline for logistics and dedicated opportunities is very strong, and we remain focused on excellent execution for our customers. While we are experiencing some improvement in demand, the length of time it will be maintained remains unclear.

With bid season approaching, we are focused on returning to growth in intermodal, leveraging our strong service and cost structure to drive conversion from truckload. As bid award realization rates improve, capacity attrition accelerates due to less spot rates and customer demand increases, we will be in a strong position to support those opportunities. Given our excellent team, creative solutions and available capacity. We will maintain our focus on providing world class service and efficiently operating our business, while executing on our long-term investment plan. With that, I will turn it over to Brian to review our operating results.

Brian Alexander: Thank you, Phil. I would like to start by thanking our talented team for their efforts and dedication in leading and executing through a changing freight environment and positioning us for growth with our customers. I will now discuss our reportable segments starting with our intermodal and transportation solutions. As Phil mentioned and we anticipated, our third quarter was challenging with ITS revenue declining 30%, driven by softer intermodal volume that declined 16%. Transcon volume declined 9%, the local west declined 18% and the local east declined 14%. Continued soft import volume, elevated seasonal inventories and an oversupply of truckload capacity generated softer volume and lower assessorial revenue in the third quarter, which led to a decline in ITS operating income.

Throughout the year, we have improved our cost structure and feel well positioned going into the upcoming bid season. In retrospect, we held the line on price for too long in 2023, which has impacted our volume. We have made the appropriate structural and process changes that are focused on regaining velocity and balance in our network and feel confident in our timing and disciplined approach for the 2024 bid season. We continue to be pleased with our dedicated trucking growth and yield expansion along with a strong pipeline of confirmed wins scheduled to onboard in the fourth quarter and early in the first quarter of 2024. As I’ve mentioned in our previous calls, we have been improving our intermodal cost structure throughout the year. Our new rail agreements are helping us move with the market to provide compelling volume for our customer base and rail service improvements have helped us better manage our equipment costs.

On the Street, we have continued to improve our dray cost by increasing our insource dray from 62% last year to 78% and have lowered our cost of third-party purchased dray. We continue to execute and see additional opportunity to improve our Street economics through regional planning improvements and fixed cost reductions. We will continue to defend our incumbency and have incremental wins that will set us up for long-term success. In addition, the recent expansion of our cross border rail solutions have already generated new wins that will expand in 2024. We will continue to invest in our intermodal business for the long-term and are confident that these investments, along with improved rail service, will help support further conversions from over the road to intermodal.

While the near-term results are impacted by low volume, we are confident that our actions will position us for growth and deliver high levels of service for our customers with sustainable profitability. Now turning to our Logistics segment. As we continue our diversification strategy to deepen our value with our customers with our integrated approach to supporting an end-to-end supply chain, we are once again successful in expanding our logistics operating income as a percent of revenue by 40 basis points. Despite the challenging freight environment, our brokerage team continues to stand out with growing volume and margin expanded throughout the quarter. Our third quarter brokerage volume was up 5% led by share gain with existing customers and continued new customer onboardings.

Our overall Logistics segment experienced a revenue decline of 12% in the third quarter, but has a strong pipeline of confirmed wins with onboardings in the fourth quarter and start of 2024. In addition, we continue to harvest cross-selling synergies with our most recent non-asset logistics acquisitions. While we continue to drive logistics growth, we are also improving our cost as we leverage our ability to establish new multipurpose logistics locations to support our growth and lower our cost. As mentioned in previous earnings calls, these locations are strategic to our hub network of freight as they enable the continued growth of our LTL, final mile and e-commerce solutions, and support inbound and outbound multimodal hub volume to service our customers supply chain needs.

We saw the benefits of these new locations in the West and Central regions supporting the growth of our LTL solutions in the third quarter, and we expect this success to accelerate heading into 2024 We will also continue to invest in our non-asset based final mile offering as we continue to onboard new customers and build more density, driving stronger service and enhanced margin performance. Our logistics pipeline remains strong with larger deal sizes and improved close ratios. Our non-asset based logistics growth strategy is playing out well, and we are in a great position to continue our trajectory of profitable organic growth and continue to integrate future acquisitions. With that, I’ll hand it over to Geoff to discuss our financial performance.

Geoff DeMartino: Thank you, Brian. Despite recessionary freight market conditions, we generated revenue of over $1 billion for the quarter and an operating income margin of 4.2%. Our diluted earnings per share for the quarter was $0.97. We generated $88 million of EBITDA and ended with over $400 million of cash on hand. During the quarter we purchased 208,000 shares of our stock for $17 million. Our purchase, transportation and warehousing costs declined slightly as a percentage of revenue as compared to the prior year, reflecting our focus on cost containment and yield management. Salaries and benefits costs rose from the prior year as we expanded our driver count by 12%, which has enabled a large increase in our in-source drayage percentage.

In addition, the inclusion of TAGG Logistics for a full quarter added $4 million of expense as compared to the prior year. This increase was offset by lower office employee costs and lower incentive compensation expense as our office headcount declined by 12% as compared to the prior year. G&A costs decreased by over $10 million due to lower legal and use tax expenses and the lease impairment charge in the prior year. Depreciation and amortization expense increased as compared to prior year due to growth-oriented investments in equipment and technology as well as the acquisition. Gain on sale was minimal this quarter, whereas the prior year benefited from very strong used truck pricing. Logistics segment revenue of $450 million was down 12% from prior year but increased 2% from the second quarter.

Segment operating income of $29 million was 6.3% of revenue, a 40 basis point improvement from the prior year. While brokerage volume grew 5% and productivity was up by over 40%, revenue per load was down 21% as compared to the strong conditions we experienced in 2022, which impacted our profitability in the quarter. This headwind was offset by growth and profitability in our managed transportation, Final Mile, and consolidation businesses as well as a full quarter of results from our fulfillment business. The benefits of our long-term acquisition strategy and cross-selling initiatives are showing in our results, with logistics segment operating income accounting for nearly 70% of total. Our logistics offering provides a more stable earnings stream and improves our positioning as a broad supply chain solutions provider.

We have a strong sales pipeline and several large recent wins which will drive profitability into 2024. ITS Segment revenue of $595 million was down 30% from prior year due primarily to lower intermodal volume and a 20% decline in revenue per load. Operating income margin declined to 2.3% as the impact of intermodal price declines and reduction in profitable assessorial charges more than offset improvements in drayage, rail and equipment costs. While soft demand conditions and abundant capacity weigh on price, the operating team performed well in reducing controllable costs and driving efficiency and we saw the benefits of our new flexible rail contracts. We are realizing the cost benefits of in-sourcing drayage with every 100 basis point increase worth approximately $1.5 million annually over the course of the cycle.

Profitability within our dedicated service line has significantly improved in 2023, reflecting improved yields and leveraging of operating expenses. Our updated guidance for 2023 assumes market conditions decline throughout the remainder of the year, with softness following the Thanksgiving holiday per more typical seasonality in our intermodal and brokerage services with stability in our more contractual service lines. For 2023, we expect to generate diluted EPS of between $5.30 and $5.40 per share. We expect revenue will be approximately $4.2 billion for 2023. For intermodal, we’re forecasting volume will decline low-double-digits to mid-teens for the full year. The remainder of the year will reflect the impact of lower prices and less assessorial and surcharge revenue, which will be partially offset by lower purchase transportation costs and improved operating efficiency.

We expect a tax rate of approximately 20 for the year. Our capital expenditure range is unchanged at $140 million to $150 million. Based on this guidance, we would expect to generate EBITDA less capital expenditures of over $250 million in 2023. Over the past several years, we have made important strategic changes to our business, including our focus on yield management, asset utilization and operating expense efficiency, which has significantly improved profitability and returns. We’ve also completed several acquisitions to build out our logistics offering and drive more stability in our earnings. While we compete in a cyclical marketplace, these actions have driven a step change in our trough to trough results, with operating margin growing from 2% in 2017 to 6% today, along with an improvement in free cash flow to over $250 million as compared to $60 million in 2017.

These strategic changes have positioned Hub Group for success in both the short and long-term time horizon in soft and strong demand environments. With that, I’ll turn it over to the operator to open the line to questions.

Operator: [Operator Instructions] Our first question is from Scott Group of Wolfe Research. Please proceed with your question.

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Q&A Session

Scott Group: Hey, thanks, afternoon, guys. So I want to try and focus on this, the ITS margin, and we don’t have a lot of history to know what it looked like in prior troughs, but it was 10% a year ago in Q3, now it’s 2%. It doesn’t feel like we’re seeing the benefits of different rail contracts or more flexibility like we’ve talked about, and it looks like the Q4 guide implies margins take another step down from here. So why are we not, I guess, why aren’t we seeing the benefits of all the stuff that you’ve talked about in margin, and where do you think we go on margin from here?

Phil Yeager: Yes. Sure Scott. This is Phil. I’ll start. So I think we have executed well in cost-outs. If you look at the quarter year-over-year, we saw cost per drayage drop 27% year-over-year. Our rail contract did actually help us offset some of the pricing pressure. I think when you’re looking at the prior year numbers; those were also somewhat inflated with high accessorial revenue as well as gains on sale, which came out. So if you normalize those, I think you are seeing a more consistent earnings pattern. Obviously, pricing has been somewhat more aggressive than we would have anticipated, and I think Brian did a good job of calling out in his prepared remarks that we didn’t necessarily move quickly enough on pricing in the first portion of bid season this time last year, which we wound up losing some share to over the road.

We now have an opportunity to garner some of that back, and given some of the spreads that we’re seeing, I think we have a significant opportunity to do so. We have a higher asset count today, and when it is not moving, you’re going to see degradation in overall margins. And so our goal is to get velocity back into the network through the upcoming bid season, and then I think you’ll really start to see the benefits of those rail contracts.

Scott Group: And so as we approach bid season, it sounds like you want to recapture some share. Do you need to – does price need to go lower from here in order to do that? Or do you think there’s an opportunity to regain share but also improve price? I would think that’s hard to get both, but I’m curious what you guys think.

Phil Yeager: Sure. So Brian addressed in his prepared remarks. Once again, I think some of the structural changes we made with our pricing group following some of the share losses to truck initially in bid season. And since then we’ve actually performed quite well and have really seen some nice wins come online, in particular in some shorter-haul markets. So we feel that our current pricing methodology actually is working, and we won’t have to go much lower. I think you also look at the spreads that we’re seeing right now between Otr and normal contract rates. It’s up in the mid-30s at this point. So we think with the combination of really strong service product, higher fuel prices, and some uncertainty around what truckload capacity in the spot market will look like. There is a significant opportunity for intermodal conversion, and we’re planning to focus on that and capture that.

Scott Group: Okay. And then just lastly, so maybe, Geoff, are we thinking about this right, that the guidance implies closer to like a 1.5% margin in ITS and Q4? If that’s right, how should we think about those segment margins into next year?

Geoff DeMartino: No, it wouldn’t be that low. I would say it’s going to be pretty consistent with where we are today from a margin percent. I think we are going to see some pressure towards the end of the year on the brokerage side. I think we performed well in Q3, and we are starting to see that often. I would say our business model, as you know, within intermodal is very asset-like from an equipment perspective. We do, like most companies have some level of fixed costs on the operations side. So if you think about incremental volume from a contribution margin perspective, those numbers are in the upper teen’s area just on a contribution margin and that’s with flat price. Obviously, price is very, very impactful. A 1% price increase on today’s financial profile is worth nearly 100 basis points in operating profits. So we are focused on returning fluidity to the network, and then pricing will be incremental upside from there.

Scott Group: Okay. I’ll pass it along. Thank you, guys.

Operator: Thank you. Our next question is from Jon Chappell of Evercore ISI. Please proceed with your question.

Jon Chappell: Thank you. Good afternoon. Phil, to your answer before on holding price too long, and Brian’s commentary on that as well, you mentioned that you lost share, you think, too, over the road. But as we try to determine how long you’ll be bouncing along the bottom with intermodal pricing, can you speak to the competitive landscape among your intermodal competitors? Is that what’s driving the race to the bottom, or is it just the overcapacity and truckload, and you feel that once that stabilizes, the whole intermodal industry can get a bit of a floor?

Phil Yeager: Yes. I think it’s mostly the overcapacity in the truckload market. We are seeing some really nice wins that we’ve brought on lately. It was just later in the overall bid season, and as you know, our bid calendar in the first quarter will reprice over 40% of our total business. So that’s where we felt as though last year we didn’t have a great overall service product, and we tried to hold the line on price, and that’s where a lot of that share went to over the road. We believe that there are a lot of questions out there from our customers on how they’re going to, as demand returns and they need to replenish inventory, how they’re going to move that product. We’re displaying a very strong rail service product. We’re showing that fuel prices are up and that the spreads between contract rates are expanding. So we think we have a very strong value proposition to bring to our customers and having a lot of great conversations at conversion.

Jon Chappell: Okay. And then, so if we think about it, now you’ve transitioned a little bit, so you’d hopefully stem the share loss. I don’t recall you giving the monthly breakdown of the intermodal volume, but maybe that will help with as you went through the third quarter, and we’re mostly through October now, maybe where you stand there?

Phil Yeager: Sure. Yes. So July was down 13%, August was down 19%, and September was down 15%. October, thus far, is down 9%. One thing I think that is worth highlighting is when we came out of Q2, June to July we actually saw a 3% sequential increase in demand. We then, July to August saw an 8% decline, and then August to September, a 9% ramp. What occurred in August, which I think was very impactful in the back half of August and really cost us, we think, 2 to 3 percentage points on total volume for the quarter was Hurricane Hilary, and it obviously was very impactful to the western portion of our network, and so that was something we didn’t call out specifically, but I think it’s important to reference as we think about the volumes for the quarter.

Jon Chappell: Okay. I appreciate it. Thank you, Phil.

Operator: Thank you. Our next question is from Jason Seidl with Cowen and Company. Please proceed with your question.

Jason Seidl: Thank you, operator. Hey, Phil. Hey, Geoff. Hey, Brian. I wanted to talk conceptually about next year. You guys announced that you have a pending dividend out here. Most companies don’t put out a new dividend announcement if they think the business is going south. So how should we think about the potential for earnings growth with the backdrop of 40% call it of your business coming due in 1Q, improving rail costs on your side and sort of an increase in your percentage of own internal drag?

Phil Yeager: Sure. No, I think it’s a great question, and I think I’ll start and let Geoff and Brian fill in. I think it’s a little early to give anything too concrete if we’re in our budgeting process, but I’ll try to do is kind of frame it up. As we look at the market, I think we’re seeing some form of peak season, which is great. We’re starting to see capacity exits and a more balanced spot market. Inventories are coming more back in line. I think from intermodal, I referenced fuel prices increasing is normally a good thing for conversion. Our service levels, even with increasing sequential volumes are holding up very well, and I mentioned that OTR versus intermodal contract spread. I think when you look at Hub, we’re far more efficient.