Which Intermodal Firms Are on Track to Outperform?

Matthew Young, CFA: Intermodal marketing companies are fresh off an unusually robust growth year in 2018, when they enjoyed significant tailwinds from the unprecedented capacity crunch in the competing truckload shipping sector.

Recall the major IMCs use the Class I railroads for the underlying line-haul movement of their containers, and they originate the vast majority of intermodal freight directly from shippers. The major providers include industry leader JB Hunt, along with Hub Group, Schneider National, and XPO Logistics.

Recall that retail sales growth is a core driver of intermodal demand, but container volume also has the overlay of truck to rail conversions, and last year, tight truckload capacity sent significant incremental cargo to the rails.

Swinging the other way this year, however, the IMCs are grappling with a hangover that will likely carry into 2020 before growth normalizes. Network disruption from precision railroading efforts among the Class I railroads has sent some freight back to the highways, but more importantly, the truckload capacity crunch has abated, capacity has loosened, and truckload rates are sharply correcting.

As a result, the IMCs are seeing heavy competition from the trucking sector, especially on shorter haul intermodal lanes. We also expect the IMCs' bidding season in early 2020 to prove somewhat challenging, keeping industry growth mostly flattish next year as well.

On the other hand, this doesn’t mean the intermodal industry will derail. Assuming no recession arises, we look for trends to normalize by 2021. On a midcycle basis, we think the intermodal industry as a whole is capable of 5.0%-5.5% total growth, including both price and volume, and the large incumbents, JB Hunt, Hub Group, and Schneider, are, in our opinion, well positioned to outperform that.

Several factors will be at play, but we look for truckload market capacity to reach a more balanced state by the second half of next year, and this should bring stability to truckload rates and relieve pressure on IMCs' truck to rail conversions. We also expect Class-I PSR-related scheduling disruption to dissipate.

On the valuation front, the major IMCs are for the most part trading in fairly valued territory, though we think Schneider National could outperform its peers given it's trading at a slight 5% discount to our DCF-derived fair value estimate, and the firm has seen marked improvement in its intermodal division execution following its chassis program.