Summary
- Schneider's fourth quarter results reflected the ongoing weakness in trucking, intermodal, and logistics freight demand, and the margin upside was likely not sustainable.
- Contract coverage will help the dedicated truckload business, and management is looking to be acquisitive in dedicated and specialty trucking.
- Shifting the intermodal business to Union Pacific should help the company's efforts to improve operating efficiency, and a greater focus on power-only in logistics makes sense.
- There's a risk of buying Schneider too early, as trucking rates continue to fall, but the valuation here is fairly appealing as 2024 should be a stronger year.
The near-term outlook for trucking is not great. Freight demand is trending lower than the year-ago level, spot rates continue to fall, and smaller operators are being squeezed out as margins vanish. At the same time, it’s no picnic in intermodal or logistics operations either, with weaker volumes driving lower results pretty much across the board. That’s not great news for Schneider National ( SNDR ), but not only has this business endured these cycles in the past, the company is built for diversified growth as demand improves later this year.
There’s still quite a bit of uncertainty as to what demand and rates are going to look like in 2023 and 2024. While many truckers are arguing that higher costs will put a floor under rates, past cycles suggest that’s not always the case. Moreover, expectations of inventory restocks driving bigger volumes later this year could be too bullish, as weak demand threatens to stretch the destocking cycle further. Even with those negatives in sight, though, I think Schneider stock is undervalued below the low-$30’s and has some appeal as an early-cycle turnaround play (turnaround from a sentiment standpoint, not an operating standpoint).
Fourth Quarter Results Beat, But It Was A Lower-Quality Beat With Less Predictive Value
The challenges facing trucking and logistics operators were certainly evident in Schneider’s fourth quarter results, as weak peak season demand definitely impacted the trucking business, and what upside there was doesn’t look to be sustainable or predictive for 2023.
Revenue declined 7% ex-surcharges and missed expectations by about 6%, with weakness across the board relative to expectations. Truckload revenue did improve by 4%, with fleet expansion (including M&A) offsetting an 8% year-over-year decline in revenue per truck per week. Dedicated held up a lot better, with a 2% decline in weekly unit revenue, while Network saw an 11% decline. This is pretty typical, as Dedicated is protected by contracts and operators like Schneider trade off the upside in tight markets for certainty in weak markets (with the Network business giving the company leverage to spot rates).
In the Intermodal business revenue fell 1% on an 8%-plus decline in volume, while Logistics revenue declined 22% on a 5% decline in volumes. While Hub Group ( HUBG ) outperformed in its Intermodal (revenue per load up 19% versus 7.5%) and Logistics (revenue up 9%), Schneider’s results weren’t really out of line with the broader group.
Schneider did alright where margins were concerned, particularly in light of weaker revenue. Overall adjusted operating income fell 16%, with the operating ratio (the inverse of operating margin) worsening by 130bp to 89%, but beating expectations by about 2% (good for a $0.01/share beat). Truckload earnings fell 21%, only slightly worse than expected, while Intermodal fell 3%, significantly better than expected, and Logistics declined 36% (worse than expected). While Intermodal did drive the upside this quarter, at least some of that came from a higher run-off of duplicate costs tied to the company’s switch to Union Pacific ( UNP ) as its Western partner.
The rest of Schneider’s EPS beat was largely driven by a lower tax rate.
Digging In Before The Rebound
For Schneider there’s not a lot to do now but control costs and plan for the recovery phase of the cycle. Contract coverage in Dedicated Truckload helps, but I do see some risk of contract renewals at lower prices and the Network business is likely looking at two or three rough quarters. As I said before, higher operating costs should create some stability on pricing, as capacity will decline as smaller operators are forced out of the business and larger carriers will simply refuse to run at a loss.
In the meantime, Schneider management is willing to be opportunistic. The company is actively looking for M&A, with an eye toward expanding its dedicated and specialty capabilities. Given the pressures on smaller operators and lower valuations across the industry, I think they could execute a deal or two.
The story in Intermodal is similar. Management is looking to improve box-turns (part of overall efficiency) and should see better results with the switch to Union Pacific. At the same time, demand is sluggish and railroad intermodal volumes recently hit their worst levels in a decade. Longer term there are still attractive opportunities to move more freight from road to rail, but rail service quality will be a key gating factor in the short term.
With the Logistics business, management has made it clear that they’re looking to prioritize their power-only service. This is when operators like Schneider supply the tractor and the driver and basically show up to haul a prearranged load (a loaded trailer). While power-only requires somewhat elevated back-office capabilities, this is a good way to leverage the company’s FreightPower technology backbone and generate better margins and returns on assets.
The Outlook
I do see risk to 2023 numbers on weaker freight demand as I outlined above. There’s also a lot of uncertainty about 2024 operating conditions and you can see this in the forward estimates. The spread between the high/low EPS estimates for FY’24 is about 26% right now, and that reflects a pretty high degree of uncertainty (the spread for Coca-Cola ( KO ), for instance, is just 8%). That’s good for investors who think they have an edge in determining how 2024 will shape up for Schneider, but it also does underline the elevated modeling uncertainty at this point in the cycle.
I’m expecting a roughly 5% revenue decline in FY’23 followed by a 5.5% bounce in FY’24 and long-term annualized growth of around 3% to 4%. I expect EBITDA margin (adjusted) to decline slightly in 2023 before rebounding to around 14.8% in FY’24 and 15.5% in FY’25. Long term, I expect free cash flow margins to improve to the higher end of the mid-single-digits, driving 5% FCF growth.
Between discounted cash flow, margin/return-driven EV/EBITDA (a 6.5x multiple), and P/E (a 14.5x multiple), I believe Schneider should trade at around $31.50 to $34. I’d note that I’m using a middle-of-the-range P/E multiple, as I believe the end of the down-cycle is in sight at this point.
The Bottom Line
It may be too early to get bullish on trucking, but the market often moves around six months or so ahead of the bottom in business fundamentals. That would line up with a late summer/early fall bottom in trucking, which is pretty much my base-case at this point. There is risk of a deeper/longer down-cycle, and Schneider’s efforts to expand profitable operations like dedicated trucking, intermodal, and power-only logistics may not all work out, but I think the risk/reward for an early-cycle play isn’t too bad.
For further details see:
Looking Past Some Near-Term Weakness, Schneider National's Model Should Drive Better Results