It’s hard to overstate the advantages of massive scale
Despite yesterday’s equities selloff, analysts are maintaining a positive view of C.H. Robinson (NASDAQ: CHRW), the largest freight brokerage and third party logistics provider in North America. This morning, Stifel’s (NYSE: SF) Bruce Chan reiterated CHRW’s ‘buy’ rating and maintained the stock’s target price of $106, a 19x multiple of Stifel’s 2020 earnings-per-share estimate of $5.56. Chan’s new report came after Stifel hosted C.H. Robinson management at a series of investor visits. Notably, Stifel is more bullish on the large 3PL than Goldman Sachs (NYSE: GS), who set its CHRW price target at $98 in a September 26 report by Matt Reustle. Yesterday, shares of C.H. Robinson dropped 3.8% to $92.55.
There are three main reasons why Wall Street thinks that C.H. Robinson will maintain its advantages over smaller competitors into Q4 and beyond. The first is CHRW’s sheer scale: it’s the largest 3PL by a factor of three and benefits from strong network effects.
“Brokers are fundamentally freight-capacity matchmakers, so liquidity is key, as is the high level of service that comes from its numerous customer reps and its office network,” wrote Chan. In other words, the more carriers and shippers a broker has access to, the easier it is to cover loads, and that advantage is exponential rather than linear, protecting margins and limiting service failures.
FreightWaves has spoken to numerous large asset-based carriers and mid-size brokerages over the past two weeks, and everyone is saying the same thing: October has been unusually soft for spot rates, even to the point of ‘falling off’. The national outbound tender rejection index (OTRI.USA) has fallen to 15.27%, its lowest point all year. In other words, only 15.27% of tendered loads are being rejected by carriers; compare that to the June surge, when turndowns on a national basis were just under 26%.
However, brokerages are well-positioned to take advantage of softening spot markets and actually widen their margins; it’s one reason why many asset-based carriers have added logistics or ‘solutions’ or brokerage divisions over the years. As spot rates deteriorate, it’s cheaper for logistics providers like C.H. Robinson to source capacity, and if CHRW’s pricing on the shipper side is based on high rates contracted early this year, the broker stands to make a lot of money. The real danger for brokerages is when spot rates accelerate so rapidly they have a hard time bringing their shipper customers up quickly enough to outrun the market.
Goldman’s Reustle put it succinctly: “CHRW is able to expand margins through year end as spot rates move down in the second half of the year.”
Stifel’s Chan explained that C.H. Robinson’s overweight exposure to contract freight will become a positive as spot rates fall against contract rates: “If one believes that we have indeed peaked, consider that C.H. Robinson has a larger contract bias than public peers, which should begin to play into the company’s favor as the cycle matures in terms of both gross margin and volumes recovery. For all the reasons that investors hated the stock in 4Q17 and 1Q18, they should like it in 2H18.”
Finally, perhaps surprisingly, C.H. Robinson possesses a technological advantage over its smaller competitors. We often talk to small and midsize brokerages who consider themselves ‘tech-driven’ or technology-oriented, but in practice this often means they have a few developers who have been able to customize enterprise software like McLeod, Salesforce (NYSE: CRM), or mesh APIs from visibility solution providers into those platforms. Stifel thinks that CHRW’s Navisphere is best-in-class technology that links customers, suppliers, offers “a multitude of realtime visibility tools and actionable intelligence, as well as substantial automation opportunities.”
Chan wrote that freight is much more complex to move than passengers, and therefore customer service and human interaction are crucial to freight matching in ways that they simply aren’t for ride-hailing.
“Whereas ride-sharing passengers are all relatively homogenous in terms of load characteristics, move within closed, intra- city local markets, and can self-correct for problems and exceptions, freight is highly varied—van vs. reefer vs. flat, hazmat vs. non, tilt or temperature sensitive, palletized or non, lift gate vs. dock-delivered, big vs. small, heavy vs. lightweight, dense vs. volumetric, et cetera,” Chan wrote. “Freight also tends to move across thousands of lanes, over long-haul irregular routes or through complex networks. And freight cannot self-correct. Freight cannot walk to its end destination if the driver cannot find a facility.”
The key for C.H. Robinson has been to use its massive resources to build technology that serves its customers needs, without over-promising a level of automation that it can’t achieve or that its customers don’t actually want.
We’ve already looked at C.H. Robinson’s cyclical advantage (selling capacity to shippers at high contract prices while buying capacity at softening spot prices); but the 3PL also has significant structural advantages. Brokerage continues to penetrate the freight markets, capturing a larger and larger percentage of loads (quadrupling in the past fifteen years), and up to 60% of brokered loads are handled by small logistics companies with less than 1% market share. At roughly 20% market share, CHRW has the opportunity to capture a larger slice of a pie that is itself growing at a robust pace.