I will get started. My name is Garrett Holland, Senior Analyst covering Transportation and Logistics here at Baird. We're very pleased to have a group participate in the conference again this year. You know, from the company, we've got Phil Yeager, President and CEO. We've got other members of the Hub Group team here with us as well, connecting with investors. So with that, we're going to get started with some opening comments from Phil, quick presentation, and then we'll head into Q&A.
Great.
Take it away, Phil.
Thanks, Garrett. Thanks very much for having us. Happy to be here again. This one's local for us, so we always love coming to the Baird conference and appreciate you hosting us. Obviously, just Safe Harbor statements don't need to go through that, but you know, wanted to start with just a little bit about who we are. We are a supply chain solutions provider. We break ourselves down into two key Intermodal and Transportation Solutions is our first one, which represents close to 60% of our revenue on an LTM basis, and 60% of our operating income on an LTM basis as well.
We're the second-largest player in the intermodal space. We have 50,000 containers, 2,600 drivers across the U.S., and focus on our partnerships in the West with the Union Pacific and in the East with the Norfolk Southern. Within ITS, we also have a dedicated trucking business, about 1,000 drivers, 5,000 pieces of trailing equipment, long-term contracts, doing high service sensitivity deliveries for our retail and consumer products customers. Our logistics business has really been a standout for us over the- this kind of more challenging freight environment, represented about 70% of our operating income in the third quarter, which is the first time we've really seen our logistics segment really drive the majority of our profitability. Within that, we have a managed transportation business that is managing $1 billion of LTL for our customers.
We have a final mile, big and bulky home delivery business, 10 million sq ft of warehousing space, and a nearly $1 billion-dollar truck brokerage that does everything from LTL to refrigerated to dry van truckload. And I think, you know, we wanted to show on the charts there really is just that, we've done a really good job while in a more challenging revenue growth environment, improving free cash flow, as well as earnings over a longer period of time.
And on the next slide, wanted to just share, you know, the... First of all, we have some long-term targets. They were long-term when we rolled them out. We're getting closer to those now, but a target of $6 billion in top-line revenue by the end of 2025, with a 4%-5.5% operating margin. On the revenue side, obviously, we have some work to do to close that gap, but we feel confident that we will, while maintaining above the target range operating income margin percentage. The way we're going to do that is continuing to do what we've done over the past several years, do a great job servicing our customers. That's going to allow us to invest back into the core business in both technology as well as containers and tractors. We're going to continue to pursue logistics acquisitions. We've done about one per year in the non-asset-based deal.
We're focusing on continuing to drive that, using excess cash to really drive one, a higher, more consistent margin profile, but also deepen the offerings that we have to our customers, become more of a supply chain solutions provider, take friction out of their network a nd then we rolled out at our most recent earnings call, a new capital allocation plan, which sets a leverage target of 0.75x-1.25 x net debt to EBITDA, which we plan to achieve over the next year or so, along with a cash dividend, a share dividend that we plan to issue at the start of next year, and a more robust share repurchase plan at $250 million while retiring our prior $83 million authorization.
So, excited to be here. Appreciate, you know, the opportunity. Looking forward to the discussion and the questions as well, b ut thank you.
That's great, Phil. With that, we'll get into Q&A. If you have a question, you know, we're all friends here. Just raise your hand or shout it out. We're happy to work it into the discussion. So maybe just to start with the context of the cycle, it's been one of extremes, first during the pandemic and now during the aftermath. You know, where are we in this freight recession, and how would you characterize performance of the Hub model?
Yeah, I think we have to be near the trough, right? You've seen spot rates really moving along the bottom here for quite some time. Not inflecting negative any further, but certainly not getting the pop that we would hope during a peak season. We are seeing more of a muted peak, some tightness in Southern California, which we hope is a good sign going into next year. But I think if you look more broadly, capacity is starting to leave the market, inventories are getting rebalanced, import levels we think will be higher next year, which is normally good for transload activity into intermodal containers. And so, that sets what we hope will be a very constructive backdrop.
We think we also have a very strong rail service product to be able to convert business that we lost to over-the-road over the last couple of bid seasons, and so we're very focused on getting that velocity balance back into our intermodal network. I think what has really stood out to us and was why we felt very comfortable rolling out the capital allocation plan was the performance of our logistics business. As you know, we've done several acquisitions over the past few years to try to build more balance in our earnings profile. I think that's really played out quite well, with you know, improving margins actually in a very difficult environment and pretty consistent revenue performance.
So, you know, the brokerage has certainly been a more challenged piece of that, and that's always going to be somewhat cyclical, but our other service lines have performed very well. Our free cash flow profile has continued to improve, and so we feel very confident in rolling out that more consistent capital allocation plan, which we hope, you know, benefits, the shareholders.
It's an interesting perspective, especially around what you're seeing in peak. I think your expectations were for muted demand into year-end. But what are shippers telling you as it relates to inventory stocking? Has this just been one big inventory, you know, cycle, or has it been worse than that? You know, and how would you characterize it?
It's obviously been a very challenging thing to get a great read on. We saw coming into the pandemic, obviously, significant shortages in inventory, and now we're on the other side of that. So, our view is that we're getting back to balance. I think it really varies by our customer segments. If you think about our retail clients, which is 45% of our total revenue, our home improvement retailers, I think, are somewhat still overstocked. There's a little bit of a ways to go to get back to total balance there. But you look at our more value-oriented retailers, like our dollar store clients or our big box retailers, they're in a much better position to get back to more normalized shipping patterns.
A s long as the consumer can hold up, and, you know, we don't see interest rates and, and savings deterioration really drive a weaker consumer, we think we should be in a good position to see some restocking. Hopefully, you know, as we were talking about outside, hopefully, you know, kind of a spring peak going in to next year.
That's great. You know, when you think about, you know, the outlook for 2024, where are you seeing, you know, early indications of shifting market conditions? You talked about pockets of tightness in California.
Yep.
You know, any more signs like that that give you confidence that, you know, the market's going to be closer to equilibrium as we work into next year?
Well, we work with some very sophisticated purchasers. In particular, our consumer products customers are going to bid right now for their intermodal business, and there is a significant interest in locking in capacity in intermodal, and I think that's normally very telling, where they are very intelligent and thoughtful purchasers, were very savvy in shifting business to over-the-road, utilizing brokers that are now in such a challenged position financially, that they need to look ahead and say, "Okay, well, how am I going to make sure that my supply chain is staying fluid, if we see a spike in demand and capacity continue to exit?"
And so that, to me, is a very big indication that you're going to see more depletion of demand in the truckload side, more demand for intermodal. You tie in a really good service product, higher fuel prices, that all plays well together to put us in a really good position for conversions.
Yeah, no, just to pick up on that topic, you know, the intermodal conversion opportunity, I think, is really important to the story. I guess, how would you size that? Obviously, the truck market's been exceptionally weak, but you're starting to see momentum now with shipper conversations-
Yeah.
- and moving more to intermodal?
Yes, very much so. Yeah, it's been actually a very constructive discussions, and we're getting wins outside of RFP, which I think is really important. You think about the nearshoring opportunity that exists as well. You know, we think about it as probably somewhere around 10 million over-the-road shipments that could be converted to intermodal. You apply our market share to that, that's a significant amount of opportunity. We need to provide a really good rail service product to get that.
Even if we're going to get back just to our current market share, or what our market share was prior to really the deterioration in the truckload market, that's about 1.5 million loads that should be shifting back to intermodal. Once again, applying our 15%-20% market share, that's going to... that alone would close the gap in our volumes from 2020.
Despite, you know, the easy truckload market, there's still significant savings. Like, where would you dimension those today just by shifting to intermodal?
Yeah, it's depending on length of haul, obviously, it's higher in the longer lengths of haul, and that's where we've seen actually our business perform best is, you know, and this has been a multi-year trend of our transcon volumes have held up much better than our shorter haul. So, in the longer length of haul, you're talking about a mid-30 percentile sort of differential between OTR contract and intermodal contract. The spot market, obviously, it's a little bit tighter right now. You get to those shorter lengths of haul, it's closer to 15%-20% on the differential, and local West, I would put closer to 30%. So, significant at this point, and that's when you start to see that conversion back to intermodal.
Help us understand the pricing approach that you took for business last year?
Yeah.
I think it was returns focused, you know, and how that changes as we think about 2024.
Yeah, so we brought this up on the call. I think, when we were in bid season this time last year, and about 45% of our business reprices through the first quarter, so it's a significant amount of our business. We did not have, one, a very good rail service product, that we were going to market with, and truckload rates were dropping quite rapidly. We did not feel as though, at the time, that we should chase those rates, and our customers, you know, were indicating to us that they were going to have to convert to over the road really regardless, right? And so, we did not chase.
We wound up, I think, losing some market share, and in the second and third quarter RFPs, we actually performed quite well because we pivoted our strategy. We saw that we needed to move more actively with the market, which is what gives us confidence going into these RFPs now, is that we've been winning in the Q2, Q3 bids. Now we're in a position where we're up for renewal on this, that book of business, and it's a large share opportunity for us to convert back.
Yeah, the market share opportunity, I think, is interesting. So, you think you've lost to the IMC peers, or is it primarily to truckload? You know, to what extent is market share really a goal at Hub Group or more of an outcome? And, you know, when in the freight cycle do you historically target or win the most share?
Yeah, I mean, it's about maintaining share with our customers, but it's also about yield quality, right? I think you've seen in the past, we look at both volume and revenue performance, and our revenue per load was outperforming the market for actually a couple of years in a row. And so, we looked at revenue share was really we were taking share, while volume, we may have been deteriorating somewhat. There's a balance you have to strike, right?
Where right now, we're seeing, you know, we have 20% of our containers stacked, and that cost is outweighing what we could get with incremental volume, and so we're very focused on let's get back to balance, fluidity, and velocity in the network. So there's trade-offs, and as market conditions move, we're, you know, constantly assessing the cost structure and how we're pricing in order to maximize what we call our margin per load day, because that is really the way we generate the highest return on capital.
That's helpful. I guess there's a lot of equipment stacked right now across the intermodal industry. I guess, do you see any irrational behavior out there, just given that potentially excess capacity?
No, I think everybody, you know, we're stacking just like everybody else to make sure we're getting our turn times back into the right place prior to a return to demand. We saw from Q2 to Q3, actually, a 10% sequential improvement in turn times. So, we feel very good that we're doing the right things to get that velocity back. We're not in a rush to unstack. We want to make sure we're generating the right returns, but at the same time, you know, if a box is sitting, it's not creating margin for us, so our preference is get them unstacked, but not do so at deteriorating margins.
And then just for context, where did pricing on the intermodal side end the, you know, 2023 bid season? You know, general expectations as we work through next year.
Yeah, I mean, this bid season, I think everybody's seen, it was certainly more challenged than what we had anticipated, really entering the year. Similar to truck, but we think, you know, better. But really, you know, I think somewhat similar to truckload pricing and give it 200 basis points sort of benefit. You know, I think as we enter next year, the conversations we're having with our customers are locking in incumbency at, you know, flattish, sort of rate levels and then really targeting network-friendly freight that helps us get more of that balance and reduce cost, through conversion.
Yeah, yeah, to the point about conversion, obviously, you need good rail service. How would you characterize rail service today from your discussions with partners? Are you confident that service is durable?
Yeah, I think the inflection from August to September, which was about a 9% sequential volume improvement for us, was a really good sign to go to our customers and say: Look, there is some resiliency here in a really fast snapback, too. And that was actually even recovering from the hurricane that impacted the UP network pretty significantly in Southern California, and we still held service levels very strong.
And so as we're going to market, we are talking about, one, obviously all the public metrics you see around hiring and staffing levels and, and velocity in their network. But, we're also showing that as really a proof of concept of the resiliency of the service level. So it has been very consistent, both east and west for us, and, I think both of our rail partners have very publicly stated they are going to have best-in-class service and that intermodal is a key priority for their growth.
You know, difference this cycle, perhaps, you know, the change in rail contract structure. Could you review that for the group? And how does that benefit your margin?
Yeah. So, it- we, in the past, really would have kind of an annual negotiation with our rail partners. We're able to move to more of a market-based sort of, pricing methodology, where we see caps and floors in our, pricing, both up and down. Used to normally just go up. So we've seen rail pricing actually go down, which has allowed us, we think, to maintain some business and also win business in RFPs. And, you know, as much as, we have seen margins come back from where they were at the peak, it has been a significant benefit for us. It's just overall aggregate pricing to the customer has been worse than, the benefit that we've been getting. I think you would see the inverse in an upward swing market, right?
Where we would see margins expanding at a faster rate than what we're paying to our, our rail partners as well. So it cuts both ways, and, but certainly a benefit. I think the other piece that we've been very focused on is reducing our drayage costs. We've, in the quarter, we brought our drayage costs down year-over-year, about 27%. That's a combination of insourcing, where we've gotten to about 78% of our drayage is done with our own drivers. That's up from the mid-50s last year, while also driving down our third-party drayage costs, which are down, about 25% on a year-over-year basis. So, we have a lot of levers we've been pulling.
I think the next phase for us, and, and this is really in process right now, is making sure that we have a perfectly run street operation, where we're moving our drivers. That comes with velocity, but we're also making sure that our containers are in the right position at the right time. There is some cleanup that we've done that really impacted the third quarter, so we think we're right sizing for current demand, which will put us in a very good position as we enter Q1.
When you think about the leverage drivers for the intermodal business, you know, how would you size those, volume versus pricing? Will those be a part of the, you know, 2024 plan, hopefully?
Yeah, yeah. So, obviously, and it's for everybody in the industry, pricing is a far more powerful driver of earnings for us and for everybody. And so, our preference is always going to be for pricing. And so, as we see that enter the market and that real floor really hit, we will be in a great position to drive yield expansion. But in the interim, we do see this volume opportunity as a way to actually improve yield, reduce the cost structure, and drive more to the bottom line. We've done a really good job of managing our fixed costs, driving our drayage costs down. Now it's about putting more in over the top, and that'll have a very good flow-through.
And be interested in your thoughts on the dedicated business, which, you know, sits in the segment. You've done a lot of work turning around performance there. Can you just talk about the growth you're seeing-
Yeah.
... and the competitive landscape and, you know, financial performance?
That has been a standout for us. I would tell you, in prior freight recessions or downturns, we would lose business in this sort of market. We would be getting tested in RFPs and have assets sitting around. We've actually seen the inverse, in this sort of market where customers are renewing with us at increases or flattish pricing, and we're getting incremental opportunities, and I think it's because we've cleaned up our operation. We're doing a great job serving our customers. We're bringing creative solutions to them. We stepped up when they had demand needs and really surged with them. So, there's a confidence in moving us in versus other providers who maybe didn't do the same.
Typically, you'd see a lot of our customers say, "Well, I need to move this all one way right now because it's so much cheaper." We're not seeing that, and I think it's, one, customers are a little concerned about what does capacity look like in, you know, two, three months, but also a recognition of the service product that we're bringing to the table.
Oh, that's great. And how should investors think about normalized profitability for ITS? Obviously, it was great performance, 2022.
Yeah.
Now, here we are. I guess, where do we settle when we think about normalized profitability?
Yeah, I think, you know, we set a 4%-5.5% sort of operating margin target for the whole company for the long term. I think what you'll see with ITS, given intermodal is somewhat more volatile, is that it will sometimes reach lows like where we're at right now, which I think with many of the changes we're making, we can have a step change on that, and drive it a little bit higher. But it will also get closer to those highs where you're near double digits or high single. Logistics will be much more stable, right? And that's part of why we've done this acquisition strategy is to stabilize that earnings.
It's getting close to about 50% of our total revenue, and we think over time, you know, not because we're shrinking intermodal, but because we're growing logistics faster, we could see that kind of balance of our earnings profile really drive a more consistent free cash generation as well. I think you'll see that somewhere in that kind of mid- to high single-digit number, typically. Brokerage, obviously, is a large component of that and is a little bit lower right now, just like every other peer. So when the market does return, we'll see a little bit of a bump there, and the rest of the business should mix up slightly as well.
I guess maybe turning the conversation more towards the logistics business, you know, clear growth area for the company. I guess, help us size the, you know, the different pieces there, managed transportation, consolidation, warehousing- final mile, brokerage. I guess, where are you seeing the best organic growth? Where do you want to invest more?
Yeah, no, it's a great question. You know, and we have tried to, with our new investor slides on the website, show a little bit more of a breakdown of the revenue mix by segment, so hopefully that's helpful for everybody. Brokerage is the largest portion of that operation, and similar to intermodal, can be somewhat more volatile, but obviously is a high free cash generation, low CapEx-related business. We think that has been a business where we're taking market share, though, because we are effectively cross-selling.
You saw our volumes in the quarter were up 5%, while we were maintaining pretty strong returns, and we feel really good about our trajectory. When demand for the spot market does return, we're going to be in a great position to grow that business above market, given what we've done thus far. I think within our managed transportation business, which is a call at about $400 million in revenue business, where we manage $1 billion of LTL for our customers, the largest opportunity for growth there has been monetizing that LTL freight.
We've developed our own cross-dock network, where we're consolidating freight into full truckloads, feeding that into our intermodal containers, as well as into our brokerage, and that has been a great growth opportunity. We're bringing on several new wins right now, mainly because LTL pricing has been so high and is driving higher. That's a benefit for us and certainly something we're excited about. Within warehousing, we've really grown that footprint to 10 million sq ft now. E-com fulfillment, as well as LTL consolidation inbound to retail, very high service level standards.
That's a business that we're going to continue to grow. It has more of an SMB client, specification, and I think that is a little bit more stable. You have a little bit higher churn in that business, but the business itself is more consistent than maybe some of the inventory drags we see within intermodal. And then big and bulky final mile, I've been very pleasantly surprised at how that has held up, given the surge in demand that we saw over the last several years. You know, we still see volumes down somewhat, but we're continuing to drive growth with new customers and a really good return business for us, given that the service sensitivity, this is their face to their consumer.
That service sensitivity, they want to continue to grow and not really squeeze you on price as much but make sure that you're getting—they're getting the best possible service product to bring to their customers. So all that put together, we think, creates this end-to-end offering where our customers can come to Hub, and we can manage seamlessly for them every component of their supply chain, and really reduce that friction that they have. So the goal is always upsell them from a single product into all of them. We have seen our brokerage has done a great job. We add about 80-100 new customers per month in our brokerage. That's all net new opportunity to feed into our other service lines, and we're very focused on targeting that cross-selling.
You know, it sounds like a lot of momentum. Has the pipeline activity slowed at all for logistics, or is that cross-selling dynamic sustained it?
You know, I think the cross-selling and, honestly, the LTL and cross-docking opportunities have been coming in very quickly. You know, and that that's really helped things up, I think, very well and creates a great pipeline that we're very focused on onboarding. I think, you know, a lot of customers as well are now thinking, you know, "Maybe I'm not an expert in managing my supply chain." I think over the last few years they've seen the whipsaw of that, and they're looking for expertise.
So, our larger outsource opportunities, which are we typically run as freight under management, so it's not typically recognized revenue, but it's very high operating margin dollars a nd we get to monetize a lot of that freight. That has really picked up as well. Those are pretty complex onboardings, but take a little bit longer from a sales cycle, but can be very impactful when you bring them on.
Through the combination of organic growth and M&A, where do you see this revenue concentration going for logistics over time?
Yeah, I think it will remain where you have... brokerage will probably remain the largest single segment, just given that there are a portion of the logistics segment, just given the size that we have at this point and the growth opportunity that we have. I think that will remain, you know, near $1 billion, call it, of revenue, and then growing, hopefully, from there. I think managed transportation will continue to grow at a very nice clip, where our renewal rates are fantastic. T hen M&A dollars-wise, we will continue to invest in each portion, adding scale or new capabilities to all of those components.
Because we think having that full breadth, that full service offering, I'll talk about final mile as an example, where we do a lot of big and bulky to job site deliveries. But what we don't do is appliance installation. We don't necessarily have our own docks. We run that all through agents. That's a great opportunity for us to move up in value to our customer as well and really even become stickier in their business. So that's just, like, one example where we think great opportunity for us.
You recently outlined a disciplined cap allocation framework. Quieter year for M&A so far. I guess, what are you seeing from an M&A standpoint in terms of the opportunity set?
Yeah, I mean, as we've all seen, obviously, earnings have come back in line or down for most of the industry. And obviously, private equity was a very active participant in the M&A market and is somewhat on the sidelines, given interest rates and some of the volatility there, and obviously, they can't lever up quite as much. So, there hasn't been as many companies coming to market, but where we've been successful is, you know, going out, building a relationship with a, with an owner, and having more of a strategic dialogue there.
We are having those conversations. We have a really good pipeline right now and, you know, are certainly hopeful to try to close something more in the near term. But that valuation disconnect has been somewhat sustained, and you know, I think you got to be able to have realistic conversations.
No, definitely like to see the discipline there. I guess, help us review, you know, TAGG or Choptank, you know, NSD. Are these- Is M&A core competency in your view now at Hub, and you know, your ability to execute on these integrations?
Yeah, I think a few years ago, I would say probably not. But we have worked really hard, not only at how do we define what looks like a good deal initially, so we aren't spending our time on things that don't necessarily fit with the strategy, all the way through the valuation and diligence process. We have great disciplines now that we have a lot of alignment and cohesion with our board on. And then into the acquisition integration, we have become much more, I think, transparent with the seller to say, "Hey, we want you to be a part of this.
Help us see where the pitfalls are where things are that are secret sauce that we don't want to touch, but also make sure we're getting the synergies that we said we're going to." And I think that balance has really gone a long way. I think the other piece that we've gotten much better at is clearing the tech backlog quickly, getting them onto our ERP, integrating CRMs, doing a lot of the fundamental work that doesn't create a backlog that you have to work through when you're doing the next deal. So we're much more disciplined on that process, and I think will allow us to go faster as we look ahead.
You know, balance sheet in great shape at Hub. You know, talk to us about, you know, leverage targets now, how quickly you expect to get there, and, you know-
Mm-hmm
... the methods which arrive at that level. Is it M&A? Is it buyback? You know.
Yeah. Well, you know, we're, as said on the call, we're not in a rush to get to the target, but we are going to be thoughtful on it. You know, at 0.75, we're at negative net debt right now, so obviously, the biggest driver is going to be M&A. And we do feel as though we have a few deals that are very interesting right now. Don't get us all the way to that target, but will get us at least, you know, a little bit of the way there. I think we will also be looking at, obviously, organic CapEx as the first two drivers of capital.
We have the cash dividend now, which is another component, but we will use, as we see M&A, either peak or valley, we will use that share repurchase as really a toggle to get within the range. So that, if that frames it up, that's kind of the way we're thinking about it. And, you know, we continue to see value in the Hub stock. So...
Question from the audience. Dan?
Yeah, just, do you mind contextualizing rail service improvement opportunities that are relevant to what it was?
Yeah, I would tell you, the last few weeks have been near the highest that I've seen, you know, in my time at HUB. In particular, in the West, it's been excellent. So, you know, we feel like, we are where we need to be in the service that we're delivering to our customers to have the conversation around, "Hey, you know, all else being equal, we're bringing you a better cost and a better service product that is more consistent. You know, you should be seriously considering conversion." And that dialogue has been effective. So, yeah, so we actually feel, as though, you know, service has been very strong, consistent, and just improving kind of sequentially every week. So, yeah.
And then final thoughts from you, Phil. Just as we leave the audience here with some of the idiosyncratic growth opportunities at the company over the next five years. You've got organic growth, that intermodal growth in logistics, clean balance sheet. You know, how would you frame it up?
Yeah, I think, you'll see us continue to invest, very intently in intermodal with a stronger service product there, with our increased focus on street operations and reducing cost and drayage, as well as with chassis. You're going to see us have, a very strong opportunity to convert business from over the road. We've talked about some of the business we have an opportunity to go after now in the automotive segment. There's nearshoring opportunities that are related to intermodal as well. All that, along with the ESG elements that are beneficial to a lot of our larger shippers, there is obviously just a significant growth opportunity in intermodal. That being 55% of our business is fantastic.
You then think about what we're doing in bringing everything together as a supply chain solutions provider, adding scale, specialization, and technology into our logistics business to differentiate us. I think along with M&A, that's going to put us in a very strong position where we're adding accretive businesses each year, integrating them thoughtfully and driving above-market growth and returns. And throw on top of that capital allocation, which we haven't done historically as a company, I think we have a great opportunity ahead. So it's an exciting time to be at Hub Group.
No, it's a great update. Thanks so much to Phil and the Hub Group team. We appreciate you being here.
Okay, thank you.
Thank you, everyone.