SNDR - J.B. Hunt: Current Slowdown Offers A Good Buying Opportunity

Summary

• The company is facing headwinds from weakening economy and inventory destocking at its customers.
• However, the company is executing well and its intermodal business should benefit as customers look to save costs during this downturn.
• The stock is trading at a lower valuation compared to its historical levels.

Investment Thesis

J.B. Hunt ( JBHT ) is experiencing a volume decline across its business due to a weakening economy and the inventory destocking at its customers. While the macroeconomic environment is tough, JBHT has a good history of executing well through the macroeconomic down cycles. This slowdown is no different with JBHT’s intermodal business poised to gain market share as its customers look to save costs during this recessionary environment by switching their highway freight to intermodal. The improvement in rail velocity and the company’s strong relations with BNSF position it to benefit during this period. I like the company’s long-term prospects and believe it will emerge stronger on the other side of the macroeconomic cycle. Hence, I have a buy rating on the stock.

JBHT’s Q4 FY22 Earnings

Recently, JBHT reported lower-than-expected fourth-quarter FY23 financial results. The revenue in the quarter grew 4.4% Y/Y to $3.65 bn (vs. the consensus estimate of $3.80 bn). The diluted EPS declined 16% Y/Y to $1.92 (vs. the consensus estimate of $2.44). The revenue growth in the quarter was primarily due to the increase in fuel surcharge revenue, partially offset by a decline in volumes in the Interload ( ((JBI))) and Integrated Capacity Solutions ( ((ICS))) segments. The diluted EPS declined significantly due to the $64 mn Y/Y increase in pre-tax casualty claim expense. This was partially offset by the company’s productivity gains.

Revenue Drivers and Outlook

JBHT is experiencing a cyclical downturn in the market resulting in lower volumes, which led to a 3% Y/Y decline in revenue (excluding fuel surcharge revenue) in Q4 FY22. The peak season activity leading up to the holidays was absent in FY22 as retailers were destocking inventory to prepare for a softening macroeconomic environment. This resulted in weak demand in the Intermodal ((JBI)) segment which saw a volume decline of 1% Y/Y in the quarter. The volumes in October were up 4% Y/Y, down 3% Y/Y in November, and down 5% Y/Y in December. It was not all bad though, and one good thing that happened in the intermodal business was an improvement in rail velocity as the quarter progressed.

In the Dedicated Contract Services ((DCS)) segment, the demand for professional outsourced private solutions remained strong, which led to a 4.6% Y/Y increase in volumes in the quarter and an 8.8% Y/Y increase in revenue per week. In Final Mile Services ((FMS)) segment, the demand for big and bulky products, including appliances, furniture, and exercise equipment, has moderated. In the Integrated Capacity Solution ((ICS)) segment, the volume declined 27% Y/Y and the revenue per load declined 9% Y/Y due to the weaker demand in the quarter. Transactional or spot volume was down year-over-year but the contractual volume was slightly up Y/Y. The volumes in the Truckload ((JBT)) segment increased by 6% Y/Y despite the challenging freight environment. This was due to the increased demand for JBHT’s drop trailer solutions, which leverage the J.B. Hunt 360° platform. The J.B. Hunt 360° platform provides shippers and carriers greater access and visibility to the supply chain.

Looking forward, the weakening economy and inventory destocking at customers is a major concern for JB Hunt which should impact volumes in FY2023. However, there are some positives as well. The improving trends around rail velocity should allow JBHT to sell higher-valued and reliable services to its customers in the intermodal business. Approximately half (47%) of the company’s revenue is generated through the intermodal business. Due to the recessionary environment and easing capacity constraints, many companies are shifting their focus toward cost savings and services versus sourcing additional capacity. JBHT’s intermodal service provides cost-saving opportunities to its customers by converting their highway freight to intermodal. While the volumes have been declining due to inventory destocking at its customers, the company is seeing opportunities to increase its wallet share by converting highway freight and transloading more international freight into its domestic containers. The improvement in the rail service level and capacity expansion investments positions JBHT well to take advantage of the current bid season. Schneider ( SNDR ) ending its business relationship with BNSF also provides a great opportunity for JBHT to increase its business with BNSF.

The company’s second major business, Dedicated Contract Services ((DCS)), which contributes ~16% to the total revenue, is usually long-term and contract based in nature as it provides specialized solutions to its customers. Hence, I believe this business should be resilient during this weakening macroeconomic condition. The Highway services businesses (ICS and JBT) are seeing weakness due to declining demand and spot rates. The company enjoyed healthy demand in the spot market over the last two years, however, with rising interest rates demand started deteriorating which led to softening in the spot market. The company is focusing on winning contract business in these segments to partially offset spot market weakness.

No doubt, FY23 is going to be a tough year for the company given the challenging macros. However, the company is positioned well to gain market share during this downturn and emerge stronger on the other side of the cycle. JBHT has a history of executing well during the down cycles and the company-specific initiatives should limit the downside in FY23. Further once the inventory destocking at the client end (likely towards the end of this year), we might see volume growth resuming next year.

Margin Outlook

JBHT has been able to improve its operating ratio since Q4 FY20 due to higher volumes, cost-recovery efforts through price hikes, and investments in technology. However, in Q4 FY22, the operating ratio increased 170 bps sequentially and 150 bps Y/Y to 92.3% due to higher casualty claims expenses as well as increased investments to attract and retain professional drivers and maintenance technicians. This was partially offset by cost recovery efforts from price hikes and productivity gains in the JBI, ICS, and FMS segments and an increase in revenue and productivity in the DCS segment. Excluding the higher casualty expense of $64 mn, the operating ratio in the quarter improved by 30 bps Y/Y to 90.5%.

Looking forward, I believe the company’s operating ratio should be impacted in 2023 due to lower volumes from declining demand. While the technology investments JBHT has made over the past several quarters and improvement in the labor market should help partially offset this headwind, I am not too optimistic about the company’s margin this year. However, in the long term, I believe the improvement in volumes and benefits from productivity gains should help improve the operating ratio.

Valuation & Conclusion

The stock is currently trading at 20.09x FY23 consensus EPS estimate of $9.20 and 18.43x FY24 consensus EPS estimate of $10.03, which is below its five-year average forward P/E of 22.21x. The company’s revenue should be impacted due to the declining demand and inventory destocking in the current year. However, I expect the destocking to be completed by the end of this year, which should benefit revenues in FY24. Additionally, the company’s revenue should benefit from the market share gains in JBHT’s intermodal business due to its ability to save costs for its customers and provide better service during this recessionary period. JBHT is a good multi-year compounding story and I believe the current slowdown offers a good buying opportunity for long-term investors.

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