Parnassus Digest - August 2013
Investment Thesis: C.H. Robinson
The future is unpredictable, so we look at a broad range of scenarios before we invest. It’s rare that we come across a company that we believe will outperform in four out of the five potential scenarios that it could encounter. It’s even rarer that we have the opportunity to invest when the stock price already reflects the one scenario where it could underperform, which limits our downside. When we find opportunities like this we take advantage of them with the goal of providing our shareholders with a good, long-term investment. In this Parnassus Digest, Ian Sexsmith, Senior Research Analyst and Portfolio Manager, shares our thoughts on C.H. Robinson..
Founded in 1905 in North Dakota, Robinson has grown to be the largest third-party logistics provider in the United States, generating more than $11 billion of total revenue from a number of shipping methods and services. Robinson doesn’t own trucks, or boats, or planes; it connects shippers with carriers, and it earns the spread between what the shipper pays and what it pays the carrier (this is called net revenue).
Exhibit 1 - Q1 2013 Net Revenue by Service Offering
Trucks (and boats and planes) are expensive to buy and maintain, and depreciate over time, so shippers often “rent” a truck for a specific load instead of buying a truck, which would sit idle between loads. Due to low barriers to entry and the lack of economies of scale, trucking is a highly fragmented industry. There were 662,544 registered interstate motor carriers as of December 31, 2011, 97% of which operated less than 20 trucks1. Brokers are the necessary link that connects this diverse group with shippers.
Robinson’s network of shippers and carriers is by far the largest in the industry, more than 2x larger than its closest competitor2. This network was difficult to build, since shippers like Target and Coke don’t trust every smooth-talking broker they meet with their critical logistics information. The network provides a competitive advantage that enabled the company to earn a 42% return on investment in 2012, which was the 9th highest ROI in the entire S&P 5003. This leads to significant excess cash flow, which its veteran management team returns to shareholders. In 2012 alone, they returned 5% of the market cap in the form of dividends and share buybacks.
Robinson’s growth has been as impressive as its returns, as its net revenue has grown at an average rate of 15% over the last 20 years. Incredibly, it’s posted positive growth for every year in this same period.
Even after this growth, the opportunity for brokers like Robinson remains enormous. U.S. trucking company revenues are estimated to have been $280 billion in 20114, of which an estimated $41 billion went through brokers5, a penetration rate of only 15%. This is surprisingly low given the fact that the industry grew at an annual rate of 12% for the last 16 years6. In addition, brokers have only just begun to tap into the private fleet market (i.e., trucks owned by shippers), where revenues are estimated to be $277 billion7.
Robinson’s historical 15% growth rate is 3% higher than the industry, because it’s taken share from small brokers. There are 10,000 licensed brokers, but less than 25 of them have total revenue of $200 million8. We believe that these secular tailwinds will be blowing for a long time, and we expect Robinson’s growth streak to continue, though, of course, there is no guarantee that this will hold true.
Exhibit 2 - Annual Net Revenue Growth
However, as the chart above shows, Robinson’s growth rate has decelerated in recent years, and the stock has fallen as a result. Several new entrants are furiously hiring, buying up small brokerage firms, and accepting tighter spreads as they attempt to cobble together networks that can compete with Robinson’s. In 2012, while Robinson’s gross revenue grew 10%, its net revenue growth rate fell to 5%, due to spread compression. While the prevailing belief is that spread compression is due to a new, persistent competitive landscape, we think the more likely reason is the unprecedented calmness in the trucking industry, caused by anemic consumer spending (demand) and stable truck capacity (supply).
We believe that the economy’s subdued recovery from the 2008-2009 recession has led to anemic-but-stable consumer spending. This has allowed shippers to rely more on low-margin, predictable scheduled shipments, and fewer high-margin, rush shipments (shippers are willing to pay more for rush shipments to avoid stock-outs). The number of trucks, meanwhile, has remained constant since 20099, so as demand has plodded forward, truck utilization rates and prices have increased, causing broker margins to compress. We think that this situation is untenable, because eventually either demand or supply will change, either up or down, and Robinson will benefit as a result. To use a term coined by the author Nassim Taleb, Robinson is “anti-fragile,” in that it should benefit from disorder, though there is no guarantee that this will hold true.
If demand increases, Robinson’s total revenue should increase as it moves more loads, especially higher-margin rush shipments. If demand decreases, Robinson’s total revenue should decrease. However, Robinson’s spread should expand as truck prices will fall more than shippers’ prices, as truckers will undercut each other in their struggle to cover fixed costs. While Robinson’s net revenue growth might not accelerate in this scenario, we believe the spread expansion, and its variable cost model, should lead the stock to outperform, as it did during the bear markets of 2000-2002 and 2008-2009.
If supply increases, the additional capacity should cause truck prices to fall, and Robinson’s margin should expand, causing its net revenue growth to catch up to its total revenue growth. If supply decreases, we believe trucks will become more difficult to find. We think Robinson’s total revenue will jump, as it receives the loads that smaller brokers are unable to place. In a normal environment, 20% of loads industry-wide are turned down, and this jumps when supply becomes constrained. CHRW’s turn down rates are close to 0%, emphasizing the value of the redundancy in its network. A number of new regulations have recently been introduced in the trucking industry that may reduce capacity; if this happens, we believe Robinson should benefit.
Perhaps the most compelling aspect of the story is that investors apparently expect the current scenario to continue indefinitely, as Robinson’s stock has fallen by 30% over the past two years, and its 18x P/E multiple is at a historical low. Even if investors are right and the current scenario continues, paying an 18x multiple for a company growing its total revenue by 10% seems like a good deal to us. While Robinson’s expected total revenue growth ranks 81st in the S&P 500, its valuation is 124th10. And let’s not forget the company’s 42% return on invested capital and the downside protection that we believe its business model can continue to provide.
Exhibit 4 - Historical Valuation 11
We don’t know which of these scenarios will occur, but it is rare to have such a favorable set of outcomes, combined with such an attractive valuation.
We appreciate your investment with us.
1Source: American Trucking Association
2Based on net revenue
3Source: Credit Suisse HOLT.
4Source: American Trucking Association.
5Source: Armstrong & Associates.
6Source: Armstrong & Associates.
7Source: American Trucking Association.
8Source: Transport Topics.
9Based on fleet data from publicly traded trucking companies.Source: Werner Enterprises.
With regard to C.H. Robinson and the Parnassus Funds, past performance is not indicative of future results. Percentage of Parnassus Funds represented by C.H. Robinson as of June 30, 2013 is 4.4% of the Parnassus Equity Income Fund, 4.1% of the Parnassus Workplace Fund, 3.6% of the Parnassus Mid-Cap Fund, and 3.2% of the Parnassus Fund. While these Funds hold C.H. Robinson stock as of the date of this Digest, there is no guarantee that the Funds will continue to hold C.H. Robinson shares in the future, as portfolio holdings are subject to change.
The views expressed in this Parnassus Digest are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds.
Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Funds and should carefully read the prospectus or summary prospectus, which contains this information. A prospectus or summary prospectus can be obtained on the website, www.parnassus.com, or by calling (800) 999-3505.