Covenant Logistics Group, Inc. Q4 FY2021 Earnings Call

Welcome to today's Covenant Logistics Group, Inc. Q4 '21 earnings release conference call. Our host for today's call is Joey Hogan. At this time, all participants will be in a listen-only mode. Later we will conduct a question-and-answer session. I would now like to turn the call over to your host, Mr. Hogan, you may begin.

Thanks, Ross, and good morning, everyone. Welcome to our Fourth Quarter 2021 conference call. As a reminder for everyone, the conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and our filings with the SEC, including without limitation, the Risk Factors section, and our most recent Form 10-K and our current year Form 10-Qs. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances. A copy of our prepared comments and additional financial information is available on our new website at www.covenantlogistics.com in the Investors tab. I'm joined on our call today by our Senior Executive Vice President and COO, Paul Bunn, and our Chief Accounting Officer, Tripp Grant. David Parker is not able to join us this morning for the call. 2021 was a record year for Covenant in many ways. Revenue, our minority investment, earnings per share, and return on invested capital, all achieved record results. Our team battled through the continued effects of the pandemic, the most difficult driver market in history, huge growth in our Managed Freight division, and leadership changes early in the year. We pushed through some large pay adjustments across the enterprise in all areas, warehouse teammates, and our office staff. Over the last year, we're excited to tackle 2022. The model of transformation that we started five years ago is really starting to prove out with continued opportunities, and our results for 2021 are directly due to the Covenant community, its hard work, and commitment to each other and our customers. In summary, the key highlights of the quarter were freight revenue grew 27% million to $267 million compared to the 2020 quarter. Our asset-based truckload group freight revenue grew 9% versus the fourth quarter of '20 with 186 less trucks. Our less asset-intensive managed freight and warehouse segments grew a combined 56%, compared to the fourth quarter of 2020. On the safety side, we produced another solid quarter with our DOT accidents rate per mile being 19% below the year-ago period. The second lowest fourth quarter on record. And 2021 for the year finished the best year on record. Our TEL leasing company investment produced a record quarter and year, contributing an additional $0.10 per share versus the year-ago period. We finished the year with an all-time low leverage ratio of 0.72, an all-time low net debt to total capitalization ratio of 15.8%, and an all-time high return on invested capital of 13%. Additionally, we are very excited to announce the commencement of a quarterly cash dividend program. Work over the last few years to deleverage the company and improve our operating model to produce more consistent results led our Board to this approval. Net indebtedness has decreased by almost $240 million over the last two years, with a potential to be close to debt-free by the end of 2022. The goal is to yield 1% on an annualized basis, and at our current share count will impact cash by about a million dollars per quarter. We continued to evaluate a full range of capital allocation alternatives to effectively deploy our cash. Now I'm going to turn it over to Paul, to provide a little bit more color on the items affecting the business units.

Thanks, Joey. For the quarter, our Managed Freight division was our largest division, both in terms of revenue and operating profit. Its revenue for the quarter grew 67%, and achieved record revenue of $321 million for 2021. Managed freight's favorable results for the quarter were primarily attributable to the robust freight market, executing on various spot opportunities, and handling overflow freight from both Expedited and Dedicated truckload operations. This division remains a major strategic growth opportunity as we have invested more operations and sales resources into the division to continue its momentum into the future. We remain excited about this leadership team and the prospects going forward. The expedited division's revenue grew by 13% versus the year-ago quarter due to both strong rate and utilization improvements. We did invest in our driving workforce during the quarter with a significant pay increase, which after several quarters of sequential decline, we were able to hold the fleet size versus the third quarter and increase our stated truck count. The driver pay investment was our third pay increase for the year and has given us momentum heading into 2022. We're very thankful that our customers value our service and supported our driving themes in this unprecedented time. The Dedicated division had a good quarter and achieved nice sequential and year-over-year margin improvement, despite some unusual corporate expenses that hit both Expedited and Dedicated in the quarter. Had it not been for the 250 basis points of unusual expenses in the quarter, Dedicated would have hit the mid-90s of our target set at the beginning of the year. Revenue per truck continues to improve as we push through our improvement plan with further rationalization coming in the first half. The 21% revenue per truck improvement in the quarter was a significant contributor to the margin improvement. A pipeline for this division is very encouraging as we start 2022. The warehouse division grew 11% due to the impact of new business late in the third quarter, and pricing to offset cost increases. Operating income was negatively impacted due to higher labor costs related to the tight labor market and escalating real estate costs for nearly leased facilities. We remain committed to our current asset-light model and continue to pursue opportunities to accelerate our growth. We're excited about this year as the operating model continues to be refined. We expect a good freight environment for the first half of the year with some moderation in the second half. Cost pressures will be meaningful in terms of wages, equipment, and over-the-road repairs for the year, but the market should allow us to pass the majority of those increases through to our customers in the form of rate increases. The first few weeks of the year were tough from a working percentage as many of our driver providers were unavailable after the holidays. But the fleet working percentage has improved greatly in recent days, and we're especially pleased with the current team count. The dedicated improvement plan continues to make progress, and we're confident that we will continue to improve the margins to high single digits in 2022. Net indebtedness is already dropping, and we expect to generate free cash in 2022, providing further opportunities to deploy cash for growth and share repurchases. Thank you for your time. We will now open up the call for any questions.

Please be prepared to ask your question when prompted. And our first question comes from Scott Group from Wolfe Research. Please go ahead, Scott.

Hey, thanks. Good morning, guys. In the earnings release, you had some comments in the outlook section about operating results. Can you give a little bit more color? I wasn't sure if that was a first-half comment or a full-year comment, if we're talking about earnings. Just any more information there would be great.

I apologize if we were unclear. Based on our current observations, we expect that our earnings for the first half will be similar to or exceed those of the first half of 2021. We have confidence from our customer commitments and market conditions. For the second half, if the market remains strong, we anticipate some slowdown but believe we can at least match our earnings from 2021 for the first half of 2022.

Okay. Great. You gave some helpful color on dedicated margins. I'm curious how you're thinking about the expedited margins this year?

Yeah, thanks, Scott. This is Paul. I think expedited margins will probably approximate '21 for '22. Q1 is starting off really strong. We've dedicated and expedited. We've done a good job getting out of the gate on rate increases early in the year. So I think you'll see margins maybe a little stronger. And then as costs continue to pile up, they could dilute a little bit, but for expedited specifically to your question, I think will be similar margins to what you saw in '21 on a full-year basis.

Right. Just to combine those two things, if expedited is similar and dedicated sees a lot of improvement, I would think there'd be some potential for earnings growth and better than flat. So maybe just tie those two together.

I think in warehousing; you should see some small improvement there too. The pipeline is pretty decent. It's all going to come down to managed freight in the overall freight market. If things stay really tight and managed freight has a year like it had this year, then we will make more money in '22 than we made in '21. If things soften up a little bit in the second half of the year, you saw the large contribution that managed freight had especially in the third and fourth quarters. I think that's where we don't have the full visibility, and that will determine whether we are a little bit under or a little bit over this year's earnings, depending on where managed freight ends up in the second half of the year.

Makes sense. And lastly, from a pricing standpoint, what are you guys seeing to start the year?

Yeah. Low single digits to high single digits to low double-digits. From a rate standpoint.

Okay. Thank you guys. I appreciate it.

Our next question comes from Jason Seidl from Cowen. Please go ahead, Jason.

Thank you, Operator. Good morning, gentlemen, and my best to David, who's not on the call. I wanted to talk a little bit about the pricing in your script that you have out there online. You talked about how the contracts are elongating, excluding Dedicated. Can you give us a sense of, sort of, what percentage of your contracts now are over a year?

Yes, I'll speak. As you know, managed trends are there's not a lot of stuff that's over a year. It's pretty short-term opportunities. And as we've said before, that's where we play in the spot market. On the Expedited side, we're probably somewhere in that 40% to 50% of contracts that are multi-year and active right now.

Okay. That's helpful. Wanted to switch back to the dedicated side when you said, if you exclude some of those unusual costs, which I'm assuming aren't going to happen again, reoccur in '22, you're about 95 at the end of the year. What set of market do we need to get this business down to that low 90 level?

I believe part of it is related to the market and part to timing. If you examine the adjusted figures, similar to the year to '95, we've been operating at around 100 or 101. There has been improvement in that area. We are continuing with the process, and you'll recall that we entered into contracts right after COVID, some of which are long-term and have allowed us to secure whatever increases we could, but they still fall short of market standards. As we transition away from those contracts in the first and second halves of the year, we'll either replace them with more market-aligned business that offers a fixed variable processing margin or renegotiate those contracts to be more in line with true DCC that includes fixed variable terms. As a result, you will continue to notice improvement. I concur that we are at a 95 run rate for Q4, and I anticipate that it will keep improving slightly each quarter for the remainder of this year. However, we are not expecting to reach a 90 by the end of Q1. We do hope to reach that by the end of the year or in the early part of '23.

All right. Well, the progress is definitely there, I didn't want to insinuate it wasn't.

Yeah.

You mentioned some contracts that are not truly DCC. What percentage of your current contracts do you find problematic?

Yeah, 30% to 40% of the contracts, but half of those come up between now and August.

Okay. That's a good sign for sure. Well, fantastic gentlemen. Those are my few and I'll turn it over to a colleague. Thank you for the time as always.

Thanks, Jason.

Thanks, Jason.

Our next question comes from Jack Atkins from Stephens. Go ahead, Jack.

Great. Good morning, everybody. Thanks for taking my questions.

Hey, good morning.

Good morning.

To start; I'd like to ask maybe a two-part question. First, can you help us think through, how the equipment market looks for trucks and trailers? Also, how that's going to change, if it changes at all, over the course of 2022? And related to Covenant specifically, within your equipment leasing investment TEL, how should that trend as we look forward?

Yeah. We had some trucks pushed from '21 into '22. It was a small amount, about 50 trucks, that pushed into the first part of '22. We'll have those by March, so they're satisfying the commitment from '21. Our '22 initial order, as well as everybody’s, what you wanted you didn't get, you got a percentage of that for '22. We've worked around that from various means, so we got about 70% of our requested order for '22. Now, for us, I don't want to say that's okay, but we're trying to pull some equipment forward that we're having problems with, that we wanted to transition to another manufacturer inside of our suppliers. For us, it's okay. Trailer market pricing is up pretty meaningfully on the truck side, but I would say it's manageable. The trailer side is a different ballgame. You look at our trailer capacity, it's pretty concentrated in a few years, and our big years to start trading, trailers will start in 2023 and will go on for five or six years. We tried to start moving that along in '22 and got zero. I mean, not even a quote for pricing. We're not a huge fleet, but we're not a small fleet. From all the suppliers, we can't commit anything, and they'll talk to you late in '22 for '23 and beyond. We've even tried to float a five-year commitment, five-year committed capacity. So again, no interest, but folks willing to talk at the end of '22. Pricing in that market from what I understand is up significantly. And so there's various theories and reasons why, but it's up significantly. TEL, on the other hand, our investment in TEL is in the truck trailer sale, resale, leasing business, and obviously it had a good record. I believe strongly we will have another record '22. They were able to get some trailer capacity; that’s their business. They're paying about 25% more for that in '22. Reefer pricing, I can't even say the number and I won't say the number because it's almost ridiculous what I'm hearing they are having to pay for reefer. The pricing they’ve been able to get out in the market to lease that equipment is unbelievable also. Sales are doing really well. I mean, the 5-million-dollar figure in the fourth quarter that they contributed to our results, some of that was gained on sale. They're very opportunistic buyers in the marketplace, and they do a great job. But it's definitely going to be higher than what we've seen over the last year or so in '22. They are going to have a really good year. We buy trucks and trailers together, the 22 of us. We have a pretty good size fleet between trucks and trailers. We chose to let them have the trailer capacity so they had opportunities this year, and we'll sort it out in '23 or going forward. The equipment market is real tight. Our trucks that were pushed in the fourth quarter into the first quarter are being delivered slightly early, which is a blessing versus what we saw over the last year or so. The schedule that's been committed to is on schedule, and no further delays that we know of.

Just to add to Joey's point about the size, give you some context; 2021 was a very light year from a capex perspective. We've talked about it throughout the quarters and had a little bit of a bump up with some deliveries in Q4 of 2021. Over the course of the year, we had I think net proceeds of around $10 million. As we think forward to 2022, just to give you an idea on the scale of how it'll look with the equipment purchases, even though it wasn't as much as we had ordered with the cutbacks, the range is about $50 million to $70 million of net capex for the year. There’s quite a significant swing as we try to normalize our capex flow in terms of maintaining capex and get it back to a normal course. A lot of which stems back to what we did in 2020 with the downsizing and the selling of older equipment. This naturally made 2021 a light CapEx year. So you're going to see a little bit of a rebound in 2022 and probably an even bigger rebound in 2023 as trailers come into the equation.

Okay. Got it. That's helpful. I guess when we think bigger picture, Joey, going back to your comments in your prepared remarks around the market, as for the outlook for the market and how it could unfold this year, it doesn't seem like there is going to be an influx of capacity coming just because of the items you just discussed on the equipment side. When you think about the idea of the second half maybe being a little bit more moderation in terms of the marketplace versus the first half, is that because of your outlook for the economy, just concerned about the Fed, or is it something that your customers are maybe telling you about their business in the second half of the year?

Just the economy. I mean, when the Fed starts raising rates, its intent is to slow the economy down. When they do, there's a lot of rhetoric around this—Is it 4, is it 8, is it 3? History shows that it's impactful. Now the question is, how big, and when do we start seeing this? But we certainly notice within six months or so, that's what history shows. Now, if this is different because of infrastructure spending, which is a natural competitor to our drivers, the construction market in general is hot with low inventories. Inventories to sales are still very low. Are there some things that overcome that to divide that impact into the economy that pushes it out, or will freight experience minimal impact because of that? I find that hard to believe but we’ll see. So, that’s just it. No, there’s no indication from customers regarding any anticipated slowdown. No one’s talking about peak either, but it’s way too early to be talking about peak.

Got it. No, that sounds good. I guess the question is, have we even stopped with peak yet? Maybe not. But I guess last question then I'll turn it over. It's on capital allocation. Obviously, there have been some significant improvements to the balance sheet over the course of the last couple of years because of the actions that you guys have taken. Business is hopefully more profitable through the cycle. Folks are looking forward to that. If the stock is kind of back down to the levels where you guys sort of initiated the Dutch tender last year, you introduced the quarterly dividend. Help us think through ways that you're contemplating returning capital to shareholders outside of the quarterly dividend. Would you look to maybe get more aggressive on open market purchases of the stock given that the Dutch tender really didn't yield the type of reduction in share count that you might have been initially considering? Could you walk us through some of the capital allocation strategies, just given the strength of the balance sheet here?

Let's go back to the expectations for cash generation for the year. It depends on whatever modeling that everybody has as far as what they expect EBITDA to contribute for '22. We feel that even with $50 million to $70 million of net capex, we will still generate cash for 2022. The dividend relatively speaks to the cash impact of that; a small sum, around a million dollars per quarter. We felt there was not only a commitment but a signal to the market and our shareholders that it was just because of where we are. Number two, what are we going to do with the cash generated this year and what we see into the future? I would say, Jack, it’s all of that. We fully intend to execute the Dutch auction in full. Some people might say that we executed it without needing to use cash. Our intent was to use the cash. People ran away from us because we kinda woke the market up thinking this stock is too cheap and I’m not going to sell it at this price. Because it ran much higher than what was our generous offer at the time of the announcement, based on some conditions that changed.

Sure. Absolutely.

And regarding cash generation expectations and planning, we’re looking at M&A. Our last acquisition was SaaS back in 2018, and we feel the model's at a place that our team can focus and execute another acquisition, size unknown. There are some strategic smaller ones that make sense as good complements and larger acquisitions similar to what the Landair acquisition was back in '18. We’re in the market looking whether it's normal share repurchases, Dutch auctions, or whatever. We're going to move, and the dividend was a start, and we'll see how it plays out, but we're excited about it. It's refreshing to be generating cash because it gives you a lot of opportunities, and we will strive to deploy that cash wisely.

Okay, that’s great. Thanks so much.

Thanks, Jack.

Our next question comes from Bert Subin from Stifel. Please go ahead, Bert.

Hey, good morning, everyone.

Good morning, Bert.

Joey, just a follow-up to your comments there. What is your view on inventory restocking? Seems like there have been concerns that perhaps retail sales start to moderate through the year. Inventory sales ratio is still at all-time lows. Are you noting any actions to rebuild inventories? And do you think that could be an offsetting tailwind if the economy does moderate from high levels in upcoming quarters?

We met with a large customer yesterday who carries a lot of inventory. I believe restocking and carrying more inventories, building more warehouses, is going to be critical. This company basically said, everybody knows what they need to do post-COVID, which is keep more inventory domestically. They've just got to get there, but it's been a firefight ever since COVID. That’s just one company's experience, but if it's a really large company that carries a lot of inventory, their comment was that this has not happened yet. But they are making plans every day to try to increase inventory levels domestically. It'll play out in two phases; I think as we walk into the stores, we’ll see empty shelves start filling up. But whenever a clear strategy is in place, the next phase will be figuring out how to fill warehouses or adding warehouses. I think people are recognizing they were too thin on inventory pre-COVID, and that understanding will prompt changes.

That makes sense. Thanks for the commentary there. Paul, my fellow national champion, my follow-up question's for you. How good do you think the improvement in Dedicated would have to be to more than offset what you're expecting to be, it sounds like some normalization to Managed Freight? Can you just give us a rough order of magnitude perhaps on OR improvement?

To offset it, Dedicated would have to be in the 80s to get anywhere close. On a longer-term basis, I don’t think Dedicated will get there this year, but I don't expect it to drop off too much. I mean, it's going to drop probably in the second half. So to fully offset it, Dedicated would need to be in the 80s, probably.

Okay. Thanks. And you can just online questions.

Our next question comes from Bruce Olephant from Oppenheimer. Please go ahead, Bruce.

Thank you. Congratulations on an excellent year. The one thing that I know we just covered, but I have to mention it. What’s a little bit disturbing is that back in August, the company realized the stock was extremely undervalued, and you decided to have a Dutch auction to commit $40 million to purchase roughly 1.7 million shares, representing about 12% of the outstanding shares. That sent a signal to Wall Street that you thought your stock was extremely undervalued. Now, with the stock where it is, selling at less than seven times earnings, it's disappointing that what we got was a small dividend for shareholders rather than management realizing some kind of buyback. It's almost like 80,000 shares got tendered on the Dutch auction. We never really raised the price, which we could have done, and it’s disappointing that there's no action taken right now.

That's a fair question, Bruce. As I said earlier, we fully intended to do that and spend that cash. Arguably, we still have that cash. Several factors influence the decision, actions, and timing, and we're still very interested considering whether it’s at seven times earnings or one point three times tangible book value. We agree with you and we're diligently working to deploy our cash as effectively as we can.

Okay.

We have a follow-up question from Bert Subin. Please go ahead, Bert.

Hey, sorry. I got sort of cut off there at the end. I just had a quick follow-up to an earlier question. You guys mentioned high single to low double-digit rate increases. Can you break that out amongst Dedicated and Expedited? Thank you.

Yeah, I would say they're pretty similar, Bert. I mean, there's not a ton of differentiation between the two. Expedited is probably a little higher on the rate side; they are probably in the low double-digits and Dedicated is probably in the high single-digits. Since most business units are about the same size from a revenue perspective, if Expedited is 11, or 12, or 13, then Dedicated is probably about eight, or nine.

Okay. That's helpful. Thanks, Paul.

Gentlemen, at this time, there are no further questions.

Okay. Well, thanks, everybody for being on the call. Thank you for your questions, Bruce, again, fair question and we agree with you, so we’re behind that. I look forward to meeting you all and visiting with you after the first quarter. Thanks a lot.

This concludes today's conference call. Thank you for attending.