In an investor note released yesterday, Sept. 10, UBS equities analyst Tom Wadewitz reported on his recent meetings with C.H. Robinson (NASDAQ: CHRW) management. Though Wadewitz maintained his ‘neutral’ rating on the stock and called out some near-term risks to the third-party logistics provider’s gross margins, he liked Robinson’s scale and ability to invest heavily in new technology.
First, there are indeed some near-term cyclical pressures that could weigh on the stock. For nearly a month, we’ve been warning that spot market risk is to the upside and that the compression of the paper-spot rate spread could hurt freight brokerages. Simply put, contract rates are still falling on a lag, even though volumes are quite healthy and spot rates have firmed. Those factors tend to paint an unfavorable picture for brokers whose revenues are tied to falling contract rates and whose spot-rate costs are flat or up.
“While CHRW’s truckload brokerage business performs well in the first several quarters of a softer freight market, falling contract rates eventually become a source of pressure on [gross margin percentage] and net revenue performance in NAST,” Wadewitz wrote. ‘NAST’ stands for North American Surface Transportation, the domestic freight brokerage comprising CHRW’s largest business unit.
Wadewitz also offered some constructive commentary on the near-term outlook for Forwarding, Robinson’s international air and ocean intermediary business, writing that the current backdrop “points to stable sequential performance in the forwarding segment.”
But the real substance of the note concerned two things: the ongoing technological transformation of Robinson’s NAST division and how it positions the company vis-a-vis secular/competitive pressures in the freight brokerage industry.
First, Robinson is spending more technology: It has increased its tech spend from about $125 million/year historically to about $200 million/year for the next five years inclusive of 2019. Wadewitz gave three examples of technology that Robinson was building to automate parts of the freight brokerage process and drive incremental efficiency: robotic process automation of email load tenders, Robinson Routes and FreightQuote.
Just under a third of CHRW’s total company net revenue comes from small shippers, which tend to be less technologically sophisticated and tend to send loads to brokers via email instead of through a transportation management system. Robinson is trying to automate the process of reading emails that contain tendered loads from small shippers and put that information into Robinson’s system; in other words, turn unstructured data into structured data.
Robinson Routes is an initiative that should drive carrier asset utilization and therefore carrier stickiness by building regular multi-load circuits that bring a driver home while minimizing empty miles. Some of the digital entrants have hit on this solution already, but Wadewitz believes that Robinson’s access to a much larger volume of freight will make it easier for the company to build these kinds of loops.
Finally, Robinson is revamping FreightQuote to provide real time rates for truckload and less-than-truckload shipments for small shippers. Again, this is not exactly an innovation but Robinson’s advantages of scale, and thus data, should drive accurate pricing on a large number of origin/destination pairs.
Wadewitz wrote that he expects those projects to bear fruit on the income statement on a multi-year basis.
Why do these technology initiatives matter? Because the competitive landscape is shifting. In 2018, for the first time, Robinson’s total volumes fell while volumes grew on an industry-wide basis (according to Cass). Wadewitz pointed out the strengths in CHRW’s position as well as some potential weaknesses.
Positives include C.H. Robinson’s scale, 2.6 times the size of its next-largest competitor, and its history of strong operating performance. Since 2002, gross margins have been cyclical, sure, but range-bound between 14% and 19% and above 15% for 15 of the last 18 years. Several multi-billion-dollar brokerages have scaled during the past 18 years without affecting Robinson’s ability to make money at all points of the freight cycle.
The negatives are that the competitive pressures are intensifying and are more complex than the largest new entrants, Convoy and Uber Freight. Wadewitz called out the other mega-brokers who are also heavily investing in technology.
“We believe the issue is broader than simply competition from relatively new players Uber Freight and Convoy and it is more relevant to consider a broader group of brokers with scale/financial resources to invest in technology and compete effectively in the market,” Wadewitz wrote. “This group would likely include TQL, JBHT’s ICS business, UPS/Coyote and ECHO along with the new tech-focused players.”
Wadewitz did make the point that Uber Freight’s announcement earlier this week of its investment in a new Chicago headquarters “appears to offer evidence that even for the tech-focused new players, brokerage is a business that requires both technology and people.”