J.B. Hunt Transport Services, Inc. (JBHT) Earnings Call Transcript & Summary

Good morning, everybody. I'm Jon Chappell, the senior transportation analyst at Evercore ISI. Thanks for joining today. This is the first of our fireside chats on the transport side for the 2-day conference. We're starting off with J.B. Hunt. With the team today, I have Darren Field, Executive Vice President, Intermodal; Brad Hicks, Executive Vice President, People and President of Highway Services; John Kuhlow, CFO; and Brad Delco from Investor Relations. I do have a fair amount of questions to run through in this 35-minute fireside chat. [Operator Instructions]

I'm going to just start with a big picture question first for really Brad, Darren or Jon before I kind of go segment by segment. But -- it's really been 3 weeks since your earnings release exactly. It seems like a lifetime in these equity markets in these freight markets. So just kind of big picture, any interesting pivots or changes of note as it relates to shipper activity or demand, rail service, general intermodal trucking pricing trends, spot or contract that we've seen as we've kind of entered February and kind of get closer to this peak season. I don't know who wants to start.

I'll start and then maybe you finish, Darren. I would say it does feel like it was a lifetime ago, but I would say that not a whole lot has changed. And so in terms of what we were seeing and what we anticipated this time of year, there's nothing new as a positive, but there's also maybe nothing new that's a negative against what we were seeing at that time. A lot of our speculation is around second quarter, starting to see rebound based on our customer feedback and the insight that we have there. And so really that kind of January into February at this point, not a whole lot different.

Yes. I would probably just kind of second all of that and say that the conversations with our customers about their supply chain, what their orders are like, what demand their customers are providing to our customers and how that translates into the need for shipments has been very consistent. Most people have commented on some seasonal weakness and weakness in this first quarter that was anticipated. It's not any different than what we would have said certainly at the end of the fourth quarter last year and no real changes. I think that the -- the customer base continues to really focus and communicate with us that they do expect a peak season in the second half of this year. They think that it gives them an opportunity to get their inventory more normal, whatever normal means to anybody anymore. But we remain optimistic about the opportunities to grow our business. Really, all of our customers are asking for more Intermodal capacity from us and we're excited about that. We continue to see an opportunity to save our customers money by converting highway business to Intermodal, and that gives us an opportunity. Now that was true at the last earnings call, and it's still true today. And I've shared in a handful of meetings we've already had today, so far, I think everything is basically what we expected. And Brad touched on it. There's no negative surprises. There's no positive surprises. Things are pretty much how we expected would be at this point.

Great. Thanks for the update. We're going to touch on Intermodal a little a little bit later. I know it's important. I know it's been the focus of most of your meetings today, but I want to make sure since we have Brad that we cover a lot of the other parts of J.B. Hunt that maybe aren't in the focus all the time. So let's start with dedicated, Brad. My personal opinion, probably one of the most perceived -- misperceived parts of your business. You expanded tremendously over the last couple of years. I think a lot of that has to do with kind of your unique ability to add equipment and labor when others in the industry and the supply chain were struggling. But that's also benefited a little bit to the detriment of the margin side of the dedicated business. So -- the question is effectively, is the pace of the growth in that business to start moderating a bit, especially given some of the freight weakness that we've spoken about in the last couple of quarters? And do you still have a very full pipeline to onboard in that dedicated market?

Yes, certainly. We did come through really the last 2 years, '21 and '22 were unprecedented growth years for our dedicated division and that product and really was about how can we solve for our customers in a constrained capacity environment. And we feel like we were advantaged in being able to do that, both from access to equipment, but that was in part due to us holding trades, that we feel the effects of and we saw some of that in '22. We're going to continue to feel that in '23, but we are hopeful and believe that we'll make really good progress on cycling our equipment a little bit more normal as we get closer to the end of the year. And then just the volume of start-up and the pressure that, that place now. We do expect to continue to sell in any environment in our dedicated. The value proposition can shift and change today in a more constrained environment. It's around the cost of capital and letting us be that arm for that customer or shipper and then certainly about risk management and risk mitigation, whereas maybe the storyline in '21 and '22 was much more around the headline around just secured consistent capacity. Now that being said, we don't anticipate a record year in sales like we saw in the last 2. And so I think that will come a lot more in line to what we've historically talked about, which is a gross sales of roughly 1,000 to 1,200 tractors that should net us on a normal year 800 to 1,000. That could be a little bit pressured on the net side this year, just given our customers' freight volumes are a little softer. And that we would see a fleet go from an 18 truck fleet, perhaps down to a 17 or 16 tractor fleet to support whatever their demand level is. And so I do feel like that will start to normalize for us this year. And so start-up expenses, which have always been a part of our dedicated model will not be overweighted. And at the same time, we should start to see some correction against the older aging equipment and more pronounced what we've felt there is in just our maintenance costs by carrying that equipment an extra year to 18 months longer than we historically do. And so hopefully, we'll start to see that in the back half of the year, but we still will be carrying surplus of trade trucks going into '24, but not anywhere near the volume that we have right now.

Okay. So just to be clear on that margin going from the pressure of the extreme growth to maybe a more normalization. Just trying to understand the timing a little bit. You said the second half, but is this kind of a long-tailed maturation process. It takes a couple of years to take that exceptional growth over the last couple of years and get it to the margin you want? Or can it kind of snap back pretty quickly as you get the fleet to the type of age that you'd like as well.

It's a little bit timing. Even with the great sales year we had last year, what, Brad, we have about 500 starts that haven't implemented yet from '22 sales. And so when we think about new business, it typically takes about 4 months for that business to onboard and start to get in line with our run rate of expectations of profitability performance. And dedicated has never been perfectly balanced in when we sell and how we sell. So even if this year as an example, if we hit our targets on our growth. But if all that happens -- it's implemented in the third or fourth quarter, we won't get the benefit of those fleets coming out of start-up in this calendar year. On the maintenance side, I think that we're going to carry that burden throughout the balance of this year for the most part. But a substantial amount of trade activity is occurring now throughout the entire year. And every time that happens, we get immediate pickup, but it won't start to feel more pronounced until we get towards the back end is the reason I state that. We still believe in our long-term targets of 12 to 14 in terms of what our margin profile is for dedicated and believe that those 2 things, more moderate on the overall growth and getting back to our normal trade cycle will get us back in that strike zone.

Great. And Jon, I just want to add a couple of comments, if I could, as I think you're aware, but to make sure the audience is aware, when you think about our dedicated business, it is really made up of hundreds and hundreds and hundreds of individual accounts. Each of those accounts is priced really to an ROIC target and obviously, margin is sort of an output of what is needed in order for us to hit that target. Some of the things and nuances of just focusing on margin percent. Fuel obviously has been a headwind to margin percent performance. Fuel is generally passed through, there's 0 margin, higher fuel prices, the more it dilutes margins. And we've sort of talked about that at times over the last several quarters of it having a year-over-year headwind on margin percent to the tune of about 100 basis points, plus or minus. Maintenance, I think, has been another headwind. You heard Brad Hicks comment on that. And so those are probably the 2 -- ones that stand out that it's -- maintenance will be a headwind for us in 2023 still. Fuel, I don't know. And then, of course, start-ups is the unknown. And so if start-ups were to slow, generally that is beneficial to margins. But if we're still growing, that's generally a good problem that we think about having. And so we sort of hope that we would see margin pressure as a result of a lot of start-ups. Only other thing I would just reiterate that was said on our last earnings call, the pipeline is as large as it was a year ago. There's a little bit more concentration with some larger deals that are in the market. So I'd say there's not as much breadth to the backlog or to the pipeline. But nonetheless, there's still a lot of opportunities for us to sell. Hey, we can free up capital, you can outsource your private fleet to us. We can get trucks. We can get drivers, we can get equipment and manage the risk and probably do so more efficiently than the customer is doing today. So there's still opportunities out there to sell into.

Okay. We like to remind Nick that he was able to hit 2,500 in a year or so.

Well, I would say, too, that of all that high volume of starts, there's nothing uncharacteristic that we've seen or any material change. And so we monitor those very closely, and they start to come out of that implementation window in that third to fourth month and get to their targeted performance kind of run rate. And I would just restate that we feel really good about the fundamentals of the business coming out of start-up just like we would expect.

Okay. Not to reveal your secret sauce, but maybe just an explanation on the pricing of the dedicated model because I think that's the biggest part of the misperception. How can the pricing hold up in a dedicated trucking business when there's such volatility and lately such a precipitous decline in the spot market?

Yes. Our approach as a starting point is really a cost-plus model that wants to balance shared risk between the fixed cost and variable cost. And so we look to identify every input that exists right now, and then we layer our margin on top of that. Among other things, typically, 5-plus year contracts that carry with it some type of indexed pricing adjustment on an annualized basis. And so that's not the segment that we see radical swings based on the market conditions. But we do have needs and costs go up, and we have to account for those in our model. And by and large, the indices that we use on the annual rate escalators account for that. Now they're not always perfect in terms of the timing. And so sometimes you get it a little bit later than you want. And sometimes you might get it even a little earlier than you needed. But over the multiyear agreements that we have, it balances itself out. And we generally don't have the need for those radical swings in rate. Most customers where we have had private fleet conversions, which is where our focus is, they used to run their own fleets. So they understand that every year, the cost of equipment goes up a little bit more. They understand that, unfortunately, insurance cost in spite of outstanding safety performance, those insurance costs and premiums have gone up every single year that I've ever worked at this company. And so when you ran a fleet, you understand that, and it's a little bit more tolerable of the conversation to work through. The proof though, is in the value that we can create for that customer. And again, as we create efficiencies, the model allows them to immediately benefit from those efficiencies because we have a model that, depending on the fleet, it could be anywhere from 40% fixed cost, 60% variable. So every time we get better efficiency, better utility, they get leverage themselves. That's very different than our transactional business model, where we're generally the recipient of the efficiency gains, and then we elect to use that in different ways. And sometimes, it's to be more cost-effective to the customer in hopes of growing our portfolio with that customer. But in dedicated, they get the benefit that day, that week, that month, as soon as we get those efficiency gains.

Great. I do want to touch on ICS and final mile at the end, but I want to shift it over to Darren now to make sure we have an appropriate time for Intermodal. So let me just start big picture first here kind of more strategic as opposed to short-term focus. You've been noticeably more willing to acknowledge your Western partner, especially by name, I think, over the last 12 months. So clearly, with 2 of your biggest competitors moving to the other Western rail provider, what does that mean for your competitive positioning, not just this year, but kind of how do you envision the next 3 to 5 years playing out?

Yes. I got asked earlier today, what is core different today versus when other competitors were at the railroad. And I want to say this loud and clear, BNSF and J.B. Hunt have worked together for decades to grow together and have been successful and effective at that. What's changed is if 2 years ago, we had gone in and looked to do some integration work together or maybe even develop a product model different than what traditional Intermodal might be. It might have been BNSF's feedback at that time to say, well, if I do that with you, then I need to do it with my other channels, and I'm not sure I can do that right now. And so that was what used to be. Today, we go in with an idea and it's absolutely let's get started on that. When should we have a meeting, who all should be involved and how do we move faster or their idea is coming to us to say, hey, international Intermodal is less effective for us. We're averaging 10 days of dwell at terminals on our international containers. And let's start to talk about the long-term future related to transloading and how can we be more effective at utilizing their assets, which are largely their terminals and our ability to educate customers on the transit quality and how can we get the equipment moved out and free up a parking space that helps them. How can we integrate our systems and literally park the container at the terminal closest to the slot on the train where it's going to get on. And what that means is over the course of a year, you find a little half mile I took out of the hassling operation at the terminal. Well, when you execute millions and millions of terminal drays to load and unload the train, that turns into real value that we can then utilize together to help grow with our customers. The next 3 to 5 years, to me, are really integrating our systems, building out processes like that, that help define a more quality efficiency program. So can their system tell our driver in the cab or the truck, where to park when he comes in the terminal before he ever gets there. Can we speed up the process of that driver entering the terminal because we're so highly integrated. And the minute we leave the shipper with the unit, that rail provider knows that we're coming and we're just communicating differently. And hey, they announced in October a massive investment in Barstow, California. And over the long term, I believe we're going to be executing a much heavier percentage of transload units out of international into domestic Intermodal, which really gives us a significant growth runway. And it gives them a significant opportunity to utilize those terminal assets more effectively than what the current international shipping has meant. So we're aligned more than we ever have been. Our executive teams meet regularly and talk through strategic initiatives. And I just -- it's different. And we have been vocal about that because it's been so important to highlight to our customer base that we're aligned in a growth trajectory, and we want to support each other in that growth, and that means we're working together differently than we ever have.