HUBG - Hub Group: Adding More Hubs

Summary

• Hub Group has announced its next bolt-on deal.
• The company has seen incredibly strong momentum so far this year, something which is clearly not sustainable.
• A strong balance sheet and solid earnings power (even if margins revert) make me cautiously upbeat here.

In November of last year I concluded that Hub Group ( HUBG ) was moving with full speed ahead. The company has made a lot of progress in its transformation process, and while valuations looked largely fair, upside might exist if the company could deliver on its 2025 targets.

Some Background

Over the past 50 years Hub Group has steadily expanded its business to provide comprehensive supply chains solutions for leading customers, supported by continued investments into containers, trucks and technology, creating a decent platform for bolt-on acquisitions.

In terms of revenues, some 60% of sales are generated from intermodal solutions, complemented by an equally large logistics and truck brokerage business. Retail, e-commerce and consumer products combined make up some 80% of sales, complemented by exposure to the automotive sector, durable goods, and other segments.

The company has steadily grown the business from $1.6 billion in 2007, as it historically posted operating margins around 4-5%, to steadily grown the business to $4 billion in 2017, albeit that margins fell a full point at that point in time.

Ever since it has been some stagnation in the shares and business which limited enthusiasm, with 2020 sales down to $3.5 billion for obvious reasons, as operating margins fell 120 basis points to 3.0% of sales. This made that earnings fell by a dollar to $2.19 per share. Shares ended that year around the $60 mark, in part because the company guided for 2021 earning to recover to more than $3 per share.

The company initially guided for earnings of $3.30 per share but hiked the guidance along the year, targeting earnings at $3.95 per share alongside the third quarter earnings report. With shares trading at $84, the company was trading at 21 times earnings based on earnings of $4 per share, but this was a bit too simplistic as margins were historically coming in at high levels. A small net cash position turned into a very modest net debt position as the company announced a $130 million deal for Choptank late in 2021, a small deal equal to 4% of Hub's own valuation.

Despite a strong year, a reasonable 21 times multiple and strong balance sheet, I was a bit cautious. The reason for that was the cyclicality of the business and the fact that the starting point was that of very strong earnings in 2021, as economic changes or labor shortages could really hurt the business, but moreover the margin performance.

What Happened?

In the near one-year period since last looking at the company, Hub has seen a mixed share price performance. Shares now trade hand at $82, virtually unchanged, to thereby outperform the market a bit, yet these shares have traded at lows at $60 in recent months.

Early in 2022, Hub posted strong results for the year with revenues up to $4.23 billion. Operating margins more than doubled to $238 million, with margins up 260 basis points to 5.6% of sales. Earnings were reported at $5.06 per share, a full dollar ahead of the guidance (by the third quarter), marking very strong momentum. Moreover, the company issued a very strong guidance for 2022, with sales seen between $4.9 and $5.1 billion, as earnings are set to rise to $5.90-$6.30 per share.

The company has seen incredibly strong momentum in the first quarter. The company hiked the midpoint of the full year sales guidance to $5.4 billion, but hiked the earnings guidance to $9-10 per share. Margins rose to 8.9% amidst strong pricing and demand, providing a huge boost to gross margins.

In August the company hiked the full year guidance further alongside the second quarter earnings report, with sales now seen at $5.6-$5.7 billion, with earnings seen as high as $10.00-$10.50 per share. The strong profitability of the firm made that the company returned a modest net cash position again, comforting as EBITDA trends around $650 million per year here (yet this earnings power is very strong right now).

Note that a lot of cash flow will go into investments, with capital spending seen at around a quarter of a billion, more than 5 times the annual depreciation charge of nearly $50 million.

Later in the month, the company has used the strong financial position to announce a $103 million deal to acquire TAGG Logistics. TAGG provides fulfillment, warehousing and transportation solutions, set to add some $200 million in revenues a year with its 800 workers. The deal is set to add some 3% to pro forma sales, as the purchase price is similar in relation to Hub's valuation, marking a true bolt-on deal.

And Now?

Truth is that I find myself performing a big balancing act. Momentum in recent quarters has been very strong, far outsized compared to historical margin performance, as these earnings will reverse at some point in time. Current earnings power of $10 per share is not sustainable, but even if they are cut in half, earnings power of $5 per share is compelling which results in a 16 times earning multiple. All of this comes amidst a still largely unleveraged balance sheet.

In the meantime, I find myself in doubt, as excess earnings are used it to buy back some stock and make bolt-on deals. The big question is of course when (and how far) margins will revert, yet current excess earnings and a strong balance sheet are really comforting factors. Given the modest relative outperformance, I am a bit cautious here, as in hindsight I would have been happy to buy in the $60-$70, levels which we have recently seen. If shares retreat to the $70 mark, I am happy to consider Hub again.

For further details see: