C.H. Robinson Worldwide's (NASDAQ:CHRW) first three months of 2018 showed much top-line promise, as trucking revenue hit double-digit growth. Yet the company had difficulty translating that momentum into higher profit -- at least of the magnitude investors were expecting. Let's delve into the quarter's report filed on May 1, starting with the headline numbers:
The raw numbers
|Metric||Q1 2018||Q1 2017||Year-Over-Year Change|
|Revenue||$3.93 billion||$3.42 billion||14.9%|
|Net income||$142.3 million||$122.1 million||16.5%|
|Diluted earnings per share||$1.01||$0.86||17.4%|
What happened with C.H. Robinson Worldwide this quarter?
Net revenue -- that is, total revenue less the costs of outsourced transportation services and logistics -- expanded in tandem with total revenue, rising 10.1% to nearly $626.0 million.
- Operating margin, however, declined by 250 basis points to 30.6% -- we'll discuss the factors behind this drop further below.
C.H. Robinson's largest segment, North American Surface Transport (NAST), enjoyed a revenue increase of nearly 18% to $2.7 billion, and a net revenue advance of 11.4%, to $414.8 million. Segment operating income similarly rose roughly 12%, to $174.1 million. This was the second consecutive quarter in which NAST hit double-digit year-over-year growth in revenue, net revenue, and operating income.
During the company's earnings conference call, CEO John Wiehoff discussed the state of the freight industry, which is currently characterized by extremely tight capacity. Wiehoff listed several factors stressing shippers, including a shortage of skilled truck drivers, a moderately expanding economy, the growth of e-commerce, and the implementation of electronic logging device (ELD) regulations. These congressionally mandated rules ensure that drivers don't work above the maximum hours allowed by law.
This imbalance between demand and supply has benefited third-party logistics specialists like C.H. Robinson. Wiehoff pointed out that the company passed on an average price increase of 21% to customers in the North American truckload business during the quarter.
Of course, higher costs are driving the price increases, and C.H. Robinson is experiencing margin compression within its long-term, contractual pricing relationships. It's able, though, to adjust pricing daily on short-term, transactional customers, as more freight activity shifts to the spot market. This phenomenon obviously provided some operating leverage in NAST this quarter.
Outside of NAST, results were of a less sanguine disposition. Revenue in C.H. Robinson's second-largest segment, Global Forwarding (which includes the business lines of ocean freight, air freight, and customs), also advanced by double digits, to $553.7 million, an improvement of 18.1%. Net revenue jumped 15.5% to $123.0 million, but operating income plunged in this segment, by 49.3%, to just $8.2 million.
The company blamed Global Forwarding's profit performance on higher operating expenses, highlighted by a 21.4% increase in head-count versus the first quarter of 2017. At least a third of this head-count expansion can be traced to last August's acquisition of Canadian freight forwarder and customs broker Milgram & Company. Management attributed the general hiring acceleration to its push to "build scale in air freight, and technology investments across all service lines."
- Robinson Fresh, the company's third major segment, which facilitates the global transportation of perishables, produced a narrative that was weaker in some respects than Global Forwarding's. The segment's top line was flat at $550.5 million, while net revenue slipped by 5.2%. Operating income slumped 37% to $9.3 million.
The net revenue dive for Robinson Fresh was the result of lower truckload volumes. According to management, increased variable compensation, and the write-off of a supplier advance, also contributed to the drop-off in income, even as the segment trimmed head count by 5.6% during the quarter.
What management had to say
During C.H. Robinson's earnings conference call, analysts were eager to discuss the disconnect between relatively healthy performance in the NAST segment and the overall decline in operating margin. In answer to a question in this vein, Wiehoff gave a thoughtful summary of the challenges facing the company's two smaller segments:
We talked through, in the prepared comments, the challenges in the Global Freight segment that we continue to grow, but we leaned in heavily on some network investments at the operating expense line item, and we will continue to rationalize those quickly to make sure that the ones that are paying off are capitalized on, and the rest of them are shut down or balanced accordingly.
In Robinson Fresh, I think you see some of the segments and verticals where repricing is even more challenging, and the sort of net revenue compression that can happen where you're less successful doing that...overall, we're not happy with the operating income performance for the quarter, but we're on top of it. We believe that we have the right model and the right disciplines in place to grow our operating income more in line with our net revenue for the remainder of this year. And long-term, that continues to be our growth strategy for value creation and growing the business together.
It should be noted that despite misgivings over operating margin, C.H. Robinson still turned in a viable first-quarter performance. After all, net income did increase by nearly 17% year over year. But investors and analysts felt that the company left money on the table by failing to optimize profits. Looking ahead to the next three quarters of 2018, capacity in the freight industry is expected to remain tight. Thus, C.H. Robinson should have opportunities to maximize revenue -- while controlling overhead costs -- in the months to come.