Investment outlook for J.B. Hunt, USA Truck improves as driver shortage looks to worsen

by Jeff Della Rosa (JDellaRosa@nwabj.com) 322 views 

In the aftermath of the recent hurricanes, the outlook of the trucking industry has improved, but more drivers might leave it for higher paying jobs close to home as they help with hurricane rebuilding efforts, exacerbating the driver shortage.

“Our concern in the near-term rests on the extent of the driver shortage that will likely put wage pressure on (near term) results, in addition to keeping truck seats empty,” said Brad Delco, trucking/transportation analyst for Little Rock-based Stephens Inc. Tractor use levels might be down at the end of August and early September as a result of the hurricanes.

“The driver shortage continues to be a very significant problem per our checks, with the recent hurricanes only adding pressure in attracting drivers toward construction jobs from rebuilding efforts. We believe carriers will start to announce new rounds of driver pay increases in the near-term and believe any discussions around driver wage increases will be an important topic on earnings conference calls.”

Delco said he’s heard “that the current driver shortage is the worst it’s been in the past 25 years” and might get worse “as drivers pursue alternative jobs related to hurricane rebuilding efforts that are higher paying and do not require them to be away from home.”

‘POSITIVE TRACTION’
However, the positive outlook of the industry has led Stifel transportation and logistics analysts to change their investment recommendations to buy, from hold for three carriers, including J.B. Hunt Transport Services of Lowell and USA Truck of Van Buren.

“The spot market is red hot and is finally providing some much needed levitation on the contract pricing front,” according to an industry update by Stifel transportation and logistics analysts.

Over the next cycle of contract negotiations, prices are expected to rise between 5% and 10%, up from the previous estimate of 1.5% to 2.5%, and in 2019, prices are projected to rise 1.5% to 2.5%.

In May, freight demand was strong but was too late to have a positive impact on contract rates in the bid season. However, after carriers reported second-quarter earnings, negotiations started to turn in their favor. They said to shippers: “We can lock you into a 2% – 3% rate increase now or you can deal with rates when the market further tightens once the ELD mandate is implemented in late 2017 and early 2018.”

This started to generate “some modest level of positive traction,” according to Stifel analysts. But after Hurricanes Harvey and Irma, the industry had the catalyst it needed to move from “modestly positive to strongly positive, as FEMA and other injected a lot of incremental demand into an already tightening marketplace as emergency supplies were rushed into storm stricken areas.”

“And the prospect for rebuilding damaged structures will create a longer than normal tail on this storm-driven incremental demand. Add in the normal retail seasonal peak, the e-commerce surge at the end of the year and the implementation of the ELD mandate on Dec. 18, 2017, and we have a recipe for a prolonged period of elevated demand, strong spot rates and sizable mid- to high-single digit contract price hikes,” according to Stifel analysts.

INTERMODAL IN BALANCE
Railroads have recently started collaborating to increase the use intermodal services. Kansas City Southern and BNSF Railway have agreed to “operate cross-border intermodal runs, which provide both partners with better access to each other’s respective markets,” according to Stifel analysts. However, the challenge with intermodal growth in North America has been in “medium haul/medium density lanes that have been effectively abandoned by the railroads in favor of concentrating as much traffic as possible in long haul/high density lanes. Intermodal will not be the growth savior without railroaders thinking outside of the box and offering new collaborative services with other railroad partners and new services in a broader array of shorter haul/lighter density markets.”

J.B. Hunt’s intermodal segment, which accounted for 67% of its operating income in the second quarter, might be negatively impacted by the recent hurricanes, according to Delco and Justin Long, transportation analyst for Stephens.

“We believe JBHT experienced some challenges in the quarter related to rail service that was further exacerbated by the storms.”

As a result, Delco and Long estimated volume growth of 6% for the third quarter, down 1.6% or about 5,000 loads from previous estimates.

“We believe imbalances that were created in the network, in addition to some driver pressures were a cost headwind in the quarter.” They also increased their operating ratio to 89.3%, from 89% in the previous quarter.

The company is the “most heavily levered to growth in intermodal, and the best positioned to convert that growth to operating income given their railroad agreements,” said John Larkin, trucking/transportation analyst for Stifel. “In a trucking environment where capacity is crunched by downward pressure from regulations and neglected infrastructure, the driver supply remains the largest constraint to that growth with intermodal demand (and LTL spill over) as the largest levers to move additional demand.”

The company’s intermodal containers are “already highly utilized, leaving the company in a whirlwind where JBHT can profitably drive rates and grow the container asset base in a controlled/rational fashion given the relatively consolidated nature of the intermodal space.”

SEGMENT CHANGES
In its dedicated segment, the company “continues to see strong demand with a robust backlog,” according to Stephens analysts. “That said, we expect this to be a noisy quarter with the acquisition/integration of (Special Logistics Dedicated), some driver wage pressure and start-up costs related to recently on-boarded business.”

In July, J.B. Hunt spent $136 million to purchase Houston-based carrier Special Logistics Dedicated, allowing J.B. Hunt to expand its e-commerce delivery platform.

Stephens analysts reduced the segment’s operating ratio to 87%, from 88%.

“JBHT’s dedicated model doesn’t just pull up to docks or commit a fixed set of assets between one or more collection of node pairs. It runs as a specialized and differentiated operation based on a combination of fixed and variable contracts where they can charge for underutilized assets, keep drivers doing difficult activities and offer specialized service,” Larkin said. “This model is quite sticky when contracts are landed.”

When truckload rates are down, it’s more difficult to land new contracts because shippers have difficulty in justifying the added cost. But when rates rise aggressively “as we are anticipating, the conversation and sales process becomes much easier,” according to Larkin.

In Integrated Capacity Solutions, or its brokerage segment, Delco and Long expected mixed results in the third quarter but better than the second quarter. In trucking, the improved industry outlook was offset by the usage level of trucks related to the storms. The company’s previous two segments, which account for about 20% of gross revenue, are expected to perform similar to the overall market, Larkin said.

On Oct. 13, J.B. Hunt is expected to report third-quarter earnings will rise to 99 cents per share, from 97 cents per share in the same period in 2016, based on a consensus of 19 analysts. Revenue is expected to rise 7.9% to $1.82 billion, based on a consensus of 13 analysts.

Shares (NASDAQ: JBHT) closed Monday at $108.99, down $2.09. During the past 52 weeks the price has ranged between $76.20 and $111.98.

‘SPECIAL SITUATION’ AT USA TRUCK
For USA Truck, it’s been in the “special situation category for some time now as underpriced contracts, irregular routing and sub optimal freight selection have made it difficult to turn a profit,” according to Larkin.

In the past two years, it has undergone “a tough operating environment and a full management turnover. We think the organization now has the right team to run the fleet and is in a position to be fully supported by a much better operating environment for truckload carriers. A stronger pricing environment is expected to alleviate some pressure on the story and provide the team with a better stance when renegotiating contracts and selecting which lanes to serve and not to serve.”

On Sept. 19, USA Truck announced it’s continuing to build its executive team by hiring Jeff Harris as vice president of maintenance.

Following are other executives the company has hired or promoted:
July 2017: Allen Lowry, vice president of safety and risk management
May 2017: Rick Hainlen, vice president of revenue operations
May 2017: Kim Littlejohn, vice president and chief technology officer
April 2017: Jason Bates, chief financial officer
April 2017: Cheryl Stone, senior vice president of human resources
January 2017: CFO James Reed promoted to CEO after Randy Rogers resigns

Like J.B. Hunt, shares of USA Truck (NASDAQ: USAK) have been rising since mid-May, from a low of $5.87 on May 17, to hitting a 52-week high of $14.10 on Sept. 29. Shares closed Monday at $13.80, down 25 cents. The company was projected to report a third-quarter loss of 2 cents per share, compared to a 9 cents per share loss in the same period in 2016, according to a consensus of analysts. Revenue should rise 1.3% to $106.8 million.

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