Logistics is a complicated but very profitable business. The third-party logistics (3PL) segment is the one which is growing fastest. 3PL firms are in the business of removing the headache of managing every moving part in a company's supply chain.
There's big money in doing things efficiently. Improvements in a supply chain and distribution system create very large, very noticeable improvements in bottom line performance for the clients of 3PL providers. In effect, logistics firms work to improve their clients' businesses, taking a cut of the improvements as a fee for their services.
You can break the logistics market into two broad segments:
- Asset – Ensuring the reliability of a supply chain requires very significant investments in everything from warehouses to trucks and trailers. Some logistics companies build out their own assets to spec for the client, meaning that they have to make large-scale investments on behalf of their customers.
- Non-Asset – Non-asset logistics companies don't own their own warehouses, trucks, or put their money on the line for their customers. Instead, non-asset 3PL firms sell primarily expertise and their own network. A non-asset 3PL firm will hire and broker shipping services on behalf of their clients.
So which model is better? From a financial perspective, non-asset firms win by a long shot. The model isn't constrained by financing, which limits all capital-intensive companies, from utilities to private prisons. As a result, non-asset 3PL firms grow without financial limitation. Shipping more product for a client is as simple as hiring more independent providers, whether it's a truck to move key inputs from warehouse to a factory, or securing a new warehouse.
CH Robinson Worldwide (CHRW) is one of the biggest logistics firms in the business, and, most importantly, it's a non-asset company. The company generates the bulk of its sales from the transportation business, which contributes nearly 90% of its gross revenue. Sales topped $11.3 billion in 2012.
What makes C.H. Robinson so attractive is its position as a market-leader and its vast network of shipping partners. The company reports working with as many as 56,000 transportation partners around the world, from trucking companies to sea shippers. In effect, C.H. Robinson has assembled the “UPS and Fedex for supply-chain management and transportation” without owning any ships, trucks, airplanes, or warehouses of its own.
When businesses need someone to manage their supply-chain, they naturally turn to a company like C.H. Robinson, which has the connections and the network to source less expensive, more efficient shipping for its customers. Customers turn to C.H. Robinson for the same reason restaurants turn to Sysco's food business – they can get everything they need at one place at a lower price due to scale. The company also serves as a known and trusted intermediary between transportation companies and business customers.
The market seems to value this 3PL company fairly. It trades for just under 25 times annual free cash flow, has a variable cost structure, and does not need to make large capital investments to add new customers. Though cyclical, 3PL is a growth story – analysts expect this space to manage annual growth twice that of general GDP growth well into the future.
The company's wide moat on top of a growing industry makes it a relative value. Most importantly, the company has an excellent capital allocation strategy. C.H. Robinson Worldwide pays out 90-100% of its earnings in the form of dividends in share repurchases. This isn't for the short-term trader, but it's a very good bet for the long-term investor.
Supposing a 4% free cash flow yield and a 5% growth rate in earnings, the company offers long-term rewards of 9% per year to shareholders. A 5% growth rate is well below high-teens, double digit growth seen in the past decade. A combination of modest margin expansion and revenue growth would easily blow out a projection for 5% growth in owner earnings.
What are your thoughts on global logistics and 3PL?