SNDR - Schneider National: Different Approach Has Helped Drive Better Results During A Prolonged Down-Cycle

2023-10-11 15:24:47 ET

Summary

• Schneider National has fared better than most in the transportation industry during a challenging year, due in part to its Dedicated trucking operations and price discipline.
• The company has continued to expand the Dedicated business, including a significant Q2'23 acquisition, and this business has some counter-cyclical attributes.
• If the destocking cycle is truly over and capacity continues to leave the market, business should rebound in 2024, but pricing may limit the near-term momentum.
• Schneider isn't likely the cyclical play with the most pure upside, but the risk-reward here is still attractive, particularly given ample uncertainties about the economy.

In what has been a worse than expected year for transports (trucking, intermodal, logistics, et al.), Schneider National (SNDR) has fared better than most. I was concerned about the risk of buying in too early when I last wrote about the company , and indeed the shares are down about 5% since then, but that's still a better performance than its truckload peers (like Heartland (HTLD), Knight-Swift (KNX), and Werner (WERN)), while intermodal and logistics providers have been more mixed ( Hub Group (HUBG) has underperformed, while J.B. Hunt (JBHT) has outperformed).

I like how management has chosen to prioritize pricing discipline (instead of chasing volumes) and the Dedicated Truckload business has had a solid counter-cyclical impact. Schneider continues to face the same pricing, demand, and capacity challenges as its peers, and the risk of a more muted recovery in 2024 is real, but I think there are company-specific drivers here that still matter. Given the valuation and relative growth/margin potential, I think Schneider is still a worthwhile name to consider.

There Likely Won't Be Much To Celebrate In Q3

Schneider has a better than average track record in recent quarters where performance relative to sell-side expectations is concerned (it was one of the few to beat Street operating income estimates in Q2), but I do think it will be tough for the company to generate a lot of upsides in the upcoming third quarter results. To that end, I note that EPS expectations for the third quarter have fallen about 20% over the last three months and by about a third since the start of the year. Others have seen their estimates fall further, but that's still far from good news.

Volumes have fallen off more sharply than expected through the third quarter, driven in no small part by inventory destocking across a wide range of sectors. While several transportation companies have commented recently that they believe destocking is over (including J.B. Hunt around the time of its acquisition of BNSF 's brokerage operations), that hasn't been reflected in the earnings expectations for many of these sectors. The worst of the destocking cycle may indeed be over, but I expect we'll see weak volumes in the third quarter across a range of industries and outlooks that point to "stable" demand at lower levels.

With weak volumes and abundant capacity that came into the market to chase the high post-pandemic rates, prices have fallen significantly this year, with spot dry van rates down around mid-teens earlier this month and down to mid-20%'s year-to-date. These weak prices, coupled with higher fuel costs that smaller carriers can't pass on as readily, are finally starting to push some capacity out of the market, but it's been a slower process than expected and there's a risk to pricing on contract renewals in 2024. Likewise, volumes and pricing have been quite weak in intermodal and logistics; Schneider has chosen to park assets rather than chase business (the company had 15% of its containers stacked at the end of Q2'23).

Inflation also continues to play its part in the mix. Companies are having to absorb higher labor and component costs, and while some providers have talked about pushing for pricing to account for these pressures in 2024, I think the capacity environment will make it hard to get those rates.

Specific to Schneider, I think Dedicated will once again be an area of strength for the company, but I do see a risk of weaker volumes in Intermodal and Logistics, and I think it may be harder to generate the same upside in margins as the Dedicated business has to carry and compensate for more weakness elsewhere in the business.

Growing Dedicated Makes Sense

I like the fact that management has not allowed this downturn to throw off the company's long-term plans. The reality is that cyclicality is just part of the business, and as the last up-cycle was unusually strong, this down-cycle has been tougher than expected. In any case, Schneider has a credible vision for growing the business, and I'm glad they're sticking to it.

With second quarter earnings, the company also announced that it had agreed to acquire M&M Transportation - a dedicated trucking company with about 500 tractors operating primarily in the Northeast. The price paid was reasonable (6x EBITDA) and the company also talked about adding more tractors to the Dedicated business in the second half of 2022. While revenue/truck did contract slightly in the Dedicated segment last quarter, it remains stronger than the over-the-road business and less vulnerable to the pressures in the truckload market (it's largely covered by contracts and small independent operators can't really take away business on price).

This follows an earlier "blocking and tackling" decision in April to use Canadian Pacific Kansas City (CP) (or CPKC) as its anchor provider of U.S-Mexico intermodal traffic. There's not much overlap here with existing operations, and I expect intermodal traffic to and from Mexico to pick up as Mexico benefits from increased near-shoring capacity additions.

The Outlook

This year has proven much weaker than I expected, as capacity providers have been willing to accept weaker pricing for longer than I'd expected. This is arguably most evident in trucking, where small carriers have used cash balances built during the boom to maintain capacity even as prices have fallen before cash operating costs, but it has also been an issue in intermodal. While Schneider has elected not to chase volume in a weak market (volume was down 14% in Q2 versus a 7% decline at J.B. Hunt and a 4% increase at Knight-Swift), revenue per load has held up better (down 8% in Q2 versus a 13% decline at J.B. Hunt and a 30% decline at Knight-Swift).

I do have concerns that this weakness will spill over into 2024. I do think volumes will improve and capacity will continue to leave the market, but I think the overhang from weak pricing could cap the upside to that recovery in 2024 and stretch the recovery into 2025. To that end, my 2023 revenue estimate for Schneider is about 12% lower than before, but my 2026 number is only about 3% lower. Likewise, while margins are going to be much weaker in 2023 than I originally expected (likewise with 2024), I do see eventual margin recovery as activity improves.

Long term, I expect around 3% to 4% revenue growth from Schneider, and I believe free cash flow margins can reach the high end of the mid-single-digits on a long-term weighted average basis, helping to drive mid-single-digit FCF growth.

Given the cyclicality of the trucking, intermodal, and logistics industries, cash flow modeling is difficult (getting the magnitude and timing of the cycles right is far from easy), but multiples-based valuation is not really any easier.

If I use the same 6.5x EBITDA multiple as before but move out to a 12-month EBITDA (from 2023 previously), I get a $31 fair value, and I'd note that a 6.5x multiple is still below the full-cycle average. If I go with my FY'25 EBITDA estimate and use that 8x full-cycle multiple and then discount back, I get a $36 fair value. Likewise, a 14.5x forward P/E multiple (slightly above the long-term average) on FY'24 EPS gets me to about $31, while a 12-month estimate comes in at $28.50.

The Bottom Line

Although Schneider shares have held up better than most, I still think there's a worthwhile upside here. The Dedicated business that has helped during this downturn will be a comparative drag when the cycle turns back to growth, but I still think it's a good business and I also like the long-term opportunities in the intermodal and logistics businesses (especially the power-only offering), as well as the cyclical leverage in the Network truckload business. Other names may offer more pure upside if the cycle truly has bottomed and starts to recover, but I like the risk-reward balance here.

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