Yesterday after trading hours, Chattanooga-based truckload carrier Covenant Transport (NASDAQ: CVTI) issued a first quarter update on the company’s financial performance. Covenant executives, including Chairman and CEO David Parker, explained that Covenant would miss Wall Street’s consensus expectations for earnings in the first quarter of 2019. Wall Street expected earnings of 36 cents per share, but Covenant said that earnings would come in between 18 and 26 cents per share.
Covenant cited fewer trucks, lower revenue per tractor per week, and fewer miles per tractor per week against tough 2018 comps as factors driving the earnings miss. Exclusive of the Landair acquisition, consolidated freight revenue should grow 5.5 percent in the first quarter year-over-year, Parker said, but that figure includes the asset-light brokerage division Covenant Transport Solutions. It is not difficult for a brokerage to add top-line revenue, and without insight into gross margins, the profitability of that revenue growth remains an unknown.
Today the truckload sector was a sea of red as Covenant led a widespread selloff; shares of CVTI fell nine percent by mid-afternoon. Knight-Swift (NYSE: KNX), Werner (NASDAQ: WERN) and Schneider (NYSE: SNDR) each dropped more than four percent. Meanwhile, the S&P 500 moved largely sidewise, up 0.25 percent on the day.
Notably, Covenant leadership did not blame the macroeconomic backdrop – gross domestic product growth is expected to be less than one percent for the first quarter and industrial data has been soft – for the earnings miss.
“We attribute the softer demand to factors such as late 2018 inventory growth in advance of the perceived impact of tariffs, the effects of the partial government shutdown on spending, and extended periods of inclement weather that impacted the timing of shipping seasonal goods as well as our ability to safely dispatch our equipment,” Parker said.
On a national basis, freight volumes (OTVI.USA) are down approximately four percent year-over-year. Covenant Transport was the first truckload carrier to acknowledge soft demand. Based on market volumes tracked in SONAR, one could expect this might be a sector challenge that is broader than Covenant.
One headwind to the earnings of all enterprise carriers is the narrowing spread between rack (wholesale) and retail diesel prices in the United States. Large carriers buy diesel fuel based on rack prices and are reimbursed by shippers through a fuel surcharge based on U.S. Department of Energy-assessed retail prices. When the spread between rack and retail widens, carriers receive an unearned windfall; when that spread (FUELS.USA) narrows, carriers take an earnings hit.
The chart above shows how the rack-retail spread narrowed from more than $1.30/gallon to just above 90 cents/gallon from the fourth quarter of 2018 into the first quarter of this year. Again, this metric should affect enterprise carriers more or less equally.
Other headwinds to Covenant’s earnings are specific to its business model, which uses team drivers to move expedited freight cross-country. Expedited freight volumes can often be the first to fall off in response to weakening consumer demand. When trucking capacity is loose and retail activity slows, demand for expedited services can weaken. The chart below displays air cargo rates from Hong Kong to North America priced in U.S. dollars:
The drop in air cargo rates is seasonal, but the 2019 first quarter decline is coming off a much lower peak than the market saw in 2018. If history is any guide, air cargo rates will continue falling through at least April.
The particular combination of headwinds facing the truckload industry will affect each carrier in a different way depending on business model; Covenant happens to be particularly exposed to demand for expedited freight. Looking forward, Covenant should benefit from the investments it is making in asset-light brokerage services, which can offset down cycles and improve yield on the asset-heavy side. CVTI plans to hire more than 200 brokers over the next two years to be housed in a large, soon-to-be-opened Chattanooga facility.