J.B. Hunt Transport Services: Rating Downgrade On Weak Near Term Outlook (NASDAQ:JBHT)

Summary

Following my coverage of J.B. Hunt Transport Services (NASDAQ:JBHT) (published on 5th Feb 2024), that I recommended a buy rating as I was positive about the growth recovery trend, which I thought was evident in the intermodal [IM] segment volume performance, this post is to provide an update on my thoughts on the business and stock. The stock is now down ~20% since. Given the poorer than expected 1Q24 performance and detail regarding pricing, competitive factors, and excess capacity in the industry, I have tapered down my optimism for a turnaround in the near term. I think a recovery is inevitable, but I am revising my rating from buy to hold for the next couple of quarters as I wait for more data that supports my view on a turnaround before revising this as a buy recommendation.

Investment thesis

JBHT reported 1Q24 results two days ago, which saw revenue of ~$2.9 billion and an operating expense ratio of 93.4%. This equates to a total operating income of $194 million, split between $102 million from IM, $94 million from Dedicated, $15 million from Final Mile, -$18 million from Integrated Capacity Solutions [ICS], and $1 million from Truck. This drove adj EPS of $1.22, which is ~20% lower than what consensus was expecting.

This set of results has really challenged my positive view of the business, as IM’s performance was worse than I’d expected. Recall in my previous post that I noted IM volume growth accelerated from 6% in Oct’23 to 8% in Dec’23, which I thought reflected the bottom’s past, but this did not play out. Volume in 1Q24 was down 0.2% year over year and down 9.5% sequentially. What was really concerning was that other IM providers seemed to be able to compete with JBHT, despite JBHT having considerable scale in the industry. This is concerning because it suggests that either JBHT’s value proposition is losing out to competitors or competitors are being a lot more aggressive on price, both of which are not favorable for JBHT. My sense is that JBHT is suffering from both fronts (management acknowledged pricing, which I have discussed more below), as evidenced by the disparity in growth rates between JBHT transcon volume, which was up only by 5% when the industry was up by more than 5% (close to 10% based on my estimates using the pixels in the image below). These data are not encouraging at all, and if they are structural (say, they happen for the next few quarters), it would permanently impair my view of the business.

Certainly, pricing in Intermodal, whether it be from truckload capacity or other Intermodal competitors, it has been competitive. 1Q24 earnings results call

Regarding pricing, I was positive in the last post given the fact that volume was seeing improvements throughout the quarters, but the volume performance in 1Q24 and industry pricing action have dampened that positivity. Although pricing (revenue per load basis) was sequentially better (-9.2% in 1Q24 vs. -12.8% in 4Q23), I am no longer as confident that this data point proves a trend given my view on volume above. Moreover, it was noted that pricing was being pushed down due to excess truckload capacity, which I think is going to continue to be a big problem because the industry currently has at least 20% of excess capacity, as noted by management.

While we believe that weak truckload pricing due to overcapacity is influencing customer decision-making, we continue to see a large amount of freight that should be converted from over-the-road to intermodal, and we have the capacity and people in place to grow with our customers and recapture share from the highway. 1Q24 earnings results call

Management’s core strategy here is to stick to focusing on the long-term (they added more intermodal container fleet), which I think is the right move as the economy moves in cycles, and one should always be ready for the upcycle. As for the near-term issue with excess industry capacity, management comments during the call were “We are also adapting in how we approach our customers and contracts in terms of our commitments”. It is unclear exactly what this means, but my takeaway is that, while this is encouraging in that they are making some moves, I don’t think this is going to have any major impact on 2024 given that about 40% of the bidding is already completed. Even the remaining 60% continues to face strong pricing pressure that might be hard for JBHT to overcome with other approaches (I believe pricing is still the most important attribute in the customer decision-making process).

Yes. So Jason, this is Darren. We’ve said before, we price about 30% in each of the first three quarters, and about 10% in the fourth quarter, and so that’s the pricing cycle that began in October of ’23, is something less than half complete, but around 40%. 1Q24 earnings results call

As for my last key takeaway from the earnings, which is another major factor that made me downgrade my rating to hold, is that weak volume seems to be taking a big toll on margins. A 9% decline in pricing led to a ~16% decline in operating income, and given the fixed cost of the business, further pricing pressure and volume declines are going to put more pressure on operating income growth. The fact that industries still have >20% excess capacity would mean that pricing is going to continue to see negative pricing growth, and with a competitive environment, I think near-term EBIT performance is going to stay weak.

Valuation

My previous model showed the potential upside if JBHT recovers from the current downcycle, and the focus was on FY27 figures. However, looking at how JBHT performed and how the market reacted (based on the share price post-earnings), I think the market focus here is not on the medium- or long-term outlook but rather the short-term outlook. Hence, I restructured my model to show the near-term value of JBHT’s shares. I believe my view on FY24 performance was too optimistic previously, and based on the results, I am expecting revenue to see a 3% decline in FY24. The underlying assumption here is that JBHT is still able to recover volume (based on current trends, I am assuming the relatively lower growth vs. the industry is something short-term and not structural yet), and that industry volume would gradually recover through FY24 (my view is for volume growth to reach ~breakeven levels for JBHT). As industry volume recovers, pricing should see lesser pressure (competitors compete less on price since volume is back).

Risks

Downside risk to JBHT is further relative share loss in its IM business, which would provide more proof that it is structurally losing share. This will have a big impact on the stock valuation because IM is the largest part of JBHT’s business. We can monitor this risk by tracking the weekly available data on the AAR website.

Conclusion

In conclusion, my rating for JBHT has been revised to a hold. Weaker than expected 1Q24 results, excess industry capacity, and JBHT’s performance compared to competitors raise concerns. While management has strategies in place to address the capacity issue, they likely won’t significantly impact 2024. Considering the current environment, I believe JBHT’s stock should reflect its near-term outlook, and a 21x forward PE is more appropriate than my previous, more optimistic valuation. I’ll revisit the buy rating when data confirms a turnaround.