This Broker’s Pricing Power Is Diminishing

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Being a market leader in a loss-making business is a recipe for disaster. Having the largest market share in an industry with declining profitability is not that much better, with revenue growth being offset by margin compression. C.H. Robinson Worldwide (NASDAQ: CHRW), one of the largest third-party logistics companies globally -- handling shipments for more than 42,000 customers through a network of more than 275 offices -- is in such a predicament.

Network effect helps maintain market leadership

As a middleman linking up shippers with cargo carriers, the network effect is a crucial source of C.H. Robinson’s competitive advantage. The value of its network increases as more companies with shipping needs and an increased number of trucking operators carrying cargo join the network. Trucking operators value C.H. Robinson for providing access to the largest network of truckload freight opportunities in the U.S., reducing the capacity underutilizationissues. On the other hand, shippers like the flexibility of having cargo capacity on demand, without incurring associated staff costs. Based on a survey by Armstrong & Associates, C.H. Robinson is the largest third-party logistics company in North America, based on revenues. In industries like third-party logistics where networks are important, market leaders with a lion’s share of the market typically strengthen their existing market position.

Despite the network effect working in its favor, C.H. Robinson is not on my buy list for a few reasons.

Broker value add in question

Brokers have traditionally justified their existence based on managing demand & supply and providing critical intelligence with insights from its network. These two factors have been called into question in recent times.

Freight demand has not fully recovered to the pre-Global Financial Crisis levels, suggesting that C.H. Robinson’s role of providing access to freight that may otherwise be unavailable is less in demand. For exmaple, some stock brokers have helped their clients accumulate large blocks of shares in illquid stocks. In the current market with balanced demand supply-dynamics, C.H. Robinson’s value-add is less apparent, leading to a loss of pricing power.

Market information on freight rates and lane quotes is also become transparent and increasingly available to C.H. Robinson’s customers. Examples of websites and software providing such market intelligence include Transport Intelligence and Lean Logistics. Similar to how price comparison sites have driven down the margins of companies in the travel industry, C.H. Robinson’s pricing power has taken a beating. This is evidenced by declining margins, with gross margin falling from 18.2% in 2009 to 14.9% for the trailing twelve months.

Concern over asset light strategy

One of the key investment merits of a broker is its asset light model, which is leveraged to cargo volume growth without exposure to cargo capacity pricing risks. Critical assets typically provide their owners with structural advantages that are not easily replicated. Given that C.H. Robinson neither owns the trucks nor has the truckers on its payroll, there is always the risk of being deprived of capacity. Cargo carriers for example, might grant preferential access to their own internal sales force if the market tightens.

Financial performance

C.H. Robinson increased net revenues for the first quarter of fiscal 2013 by 9.9%, but saw quarterly net income fall by 3.0% on margin compression. Management acknowledged that truckload margins will remain challenging going forward; It will take an unexpected spike in freight demand to shift demand-supply dynamics in C.H. Robinson’s favor.

Peer comparison

C.H. Robinson’s peers include Expeditors International (NASDAQ: EXPD) and UTi Worldwide (NASDAQ: UTIW).

I prefer Expeditors International over C.H. Robinson, given its international exposure and asset medium business model. C.H. Robinson derived 90% of its fiscal 2012 revenues from North America, while Expeditors International is diversified geographically, with operations across Latin America, Asia Pacific, Europe, Africa, and the Middle East. Given the economically sensitive nature of the logistic business, it will not hurt to put your eggs in different baskets. In addition, Expeditors International provides more value than C.H Robinson by consolidating the shipments of its clients through the bulk purchases of cargo space and assuming all responsibility for shipping operations, such as clearing customs and storage. As a reflection of this, Expeditors International’s gross margins are higher than that of C.H Robinson, and have remained stable at around 30% for fiscal 2011 and 2012. It also delivered a decent set of results for the first quarter of 2013, growing quarterly earnings by 5% year-on-year.

Similar to Expeditors International, UTi Worldwide is a geographically diversified logistics company with no single geographic region accounting for more than a third of revenues. However, I am negative on UTi Worldwide, given its historical margins and recent financial results. It registered a 7.5% year-on-year decline in quarterly revenue and was in the red with a net loss of $12.4 million, compared to quarterly earnings of $12.9 million a year ago. Historically, its operating margins are in the range of 2%-3%, compared with 6%-7% and 9%-10% for C.H. Robinson and Expeditors International respectively. UTi Worldwide’s relatively smaller scale and acquisition-driven growth strategy are some of the contributing factors to its inferior margins.

Conclusion

While I like C.H. Robinson for its network effect-derived competitive advantage, I have issues over its broker value-add and asset light model. Among the third party logistics companies, my top pick is Expeditors International for its value-added services and superior margins. All three stocks are valued at similar 18-21 times forward earnings, but Expeditors International stands out with a debt-free balance sheet.

 

More financial ideas from the Motley Fool

Tax increases that took effect at the beginning of 2013 affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "How You Can Fight Back Against Higher Taxes," the Motley Fool's tax experts run through what to watch out for in doing your tax planning this year. With its concrete advice on how to cut taxes for decades to come, you won't want to miss out. Click here to get your copy today -- it's absolutely free.


Mark Lin has no position in any stocks mentioned. The Motley Fool owns shares of Expeditors International of Washington. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus