HUBG - Hub Group Still A High-Quality Play On Asset-Light Freight Management

Summary

• Hub's fourth quarter results came up a little short at the operating line, but the company executed well through a challenging fourth quarter that saw a weak seasonal peak.
• With most of the company's contracts repricing in the first half and freight demand still shaky, there could be some turbulence in results and sentiment.
• Freight demand should improve later in the year on restocking demand, provided the economy doesn't slip into a more severe recession, and M&A could be a near-term driver.
• Uncertainty over freight demand and rates could create some pullback opportunities, but Hub Group looks undervalued below $100.

Freight markets are challenging right now, but Hub Group (HUBG) is built to not only last through this downswing, but continue to grow nicely on the other side of it. Earnings have basically tripled since the start of the pandemic, and while there will be something of a reset for the business in the first half of 2023, I see ongoing opportunities to benefit from growth in intermodal, brokerage, and logistics, including opportunistic M&A.

Hub shares are up about 15% since my last update , largely just keeping pace with the wider transport group, but modestly outperforming peers like J.B. Hunt (JBHT) and C.H. Robinson Worldwide (CHRW). With management's guidance for FY'23 quite close to my prior estimate, I'm not changing too much in my model and a long-term outlook for around 4% revenue growth supports a fair value above $100.

An Operating Miss In Q4, But The Street Feared Worse

Given a weak holiday season, I believe there was more worry than normal going into Hub's fourth quarter report. While the company did miss at the operating line, management's guidance and commentary on 2023 was reassuring.

Revenue rose 2% as reported, missing by about 7%. Intermodal revenue rose 5%, as strong legacy pricing (revenue per load up 19%) was offset by weaker volumes (down 12%). Brokerage was down 11% and was the biggest source of downside versus expectations as there was far less of a scramble for capacity in the quarter. Logistics revenue rose 9% in the quarter, helped in part by cross-selling opportunities from the TAGG acquisition.

Gross margin declined a point from the year-ago quarter and 60bp from the prior quarter to 15.9%, and EBITDA declined 3%. Operating income declined 11% and missed expectations by about 1%, which translates into about $0.05/share of earnings. Lower "other" and taxes relative to expectations drove the bottom-line beat.

Guidance De-Risks Sentiment For Now

With a weak peak holiday season, fundamentals for the industry/sector were weak to start the bidding season and freight demand just isn't all that strong right now, though volumes are up about 9% from a weak December. In the case of the Intermodal business, for instance, Hub pointed to retail inventory levels as one of the drivers of weaker demand through the peak season.

Management started off the year with a guidance range that basically bracketed Street expectations going into the quarter ($5.2B - $5.4B, with the Street at $5.3B; EPS of $7.00 to $8.00 versus the Street at $7.55).

Hub will have a pricing tailwind to start off the year, but with 75% of volumes repricing in the first half of this year, there is still some potential volatility in the outlook. On a more positive note, though, I do expect a restocking cycle later in the year that will drive stronger volumes. All told, while the first quarter could still have some downside risk, business should improve from there and I think there will be opportunities for improved guidance thereafter.

Looking past the near term, I do see some ongoing potential drivers for the business. First, I see an opportunity for further shifts of on-the-road truck volumes to rail (intermodal), but a key gating factor here is improved rail service consistency. With softer demand, I would expect rail operators to address some of their prior issues.

M&A is another significant driver in my outlook for Hub, though I don't model it explicitly. Hub has long been a willing acquirer, using deals to add scale and expand into adjacent asset-light businesses (like truck brokerage and logistics). Management has put share buybacks on pause for the time being, while it evaluates a more robust M&A pipeline, and I think additional M&A will prove to be a net positive for shareholders over the longer term.

The Outlook

Given how Hub has performed and how I expect the economic situation to develop in 2023, I was tempted to change almost nothing in my model. I was expecting $5.43B in FY'23 revenue as of my last article, and I do think management is starting the year off with a prudently cautious initial guidance number. Even so, I'm going to err on the side of caution and trim my FY'23 and FY'24 numbers slightly to offset some price and volume risk, but I'm still looking for long-term revenue growth around 4%.

I've also made very modest adjustments that drive slightly lower EBITDA margin estimates for FY'23 and FY'24. While I do expect a year-over-year margin decline (from 11.8% to 9.7% and then to 9.4%), those margins are still comfortably above pre-pandemic levels (around 7.5%). I'm still looking for free cash flow margins to reach 4% and higher on a sustained basis, driving mid-single-digit long-term adjusted FCF.

Discounted cash flow and a multiples-based approach both suggest Hub Group remains undervalued. I get a fair value over $100 on my cash flow model, and I likewise believe 6.75x is a fair forward multiple on EBITDA based upon what the market has historically paid for similar levels of margins and returns. That supports a fair value over $105.

The Bottom Line

Transportation is a cyclical business, but I continue to believe in an attractive long-term opportunity for Hub Group and its shares. Choppy conditions and a weakening economy could create some pullbacks and buying opportunities in the first half of the year, but I think this is a stock still worth buying and owning today.

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