Covenant Transportation Group Inc. (NASDAQ: CVTI) will continue to allocate more equipment to its dedicated offering in efforts to lower financial leverage and gain more predictability into operations.
On the company’s fourth-quarter 2019 earnings call with analysts and investors, Covenant Transportation’s management team said that they have seen solid results from the company’s dedicated operations and prefer the economics of the business model to that of its solo-driven refrigerated unit, which has been pressured of late.
The company has been significantly increasing its exposure to dedicated for more than a year now.
The Chattanooga-based truckload (TL) carrier reported fourth-quarter 2019 adjusted earnings per share (EPS) of $0.10, below analysts’ expectations for $0.27 per share, after the market closed on Thursday. The result included a $0.02 per share loss associated with a customer bankruptcy at an affiliate.
Covenant plans to reallocate roughly 500 tractors to dedicated service in 2020 away from its less predictable offerings like refrigerated. By the time these efforts conclude, Covenant Transportation Chairman and CEO David R. Parker believes the unit could account for 60% of the carrier’s total revenue.
Parker said that there is “lower risk” in the dedicated model as daily capacity and freight commitments are firmer and the contracts are difficult to unwind as the carrier is more embedded in the shipper’s supply chain. Further, shippers typically incur large exit fees when getting out of a dedicated contract.
Management highlighted recent wins in dedicated and managed freight (freight brokerage, transportation management services, warehousing and other offerings). Covenant will be onboarding five new contracts by the end of second quarter 2020 representing approximately $50 million to 60 million in incremental annualized revenue.
The company’s capital commitments are expected to move lower in 2020 as well.
Currently, Covenant has 625 tractors that are expected to be traded in or sold in the secondary market. Management said that a good portion of this equipment is scheduled for replacement, but there could be some attrition in the overall tractor fleet that closed the year at 3,021. The official guide calls for the company’s tractor count to be flat to down 2% in 2020, but Parker said that count could move lower if Covenant wasn’t successful raising rates on a few lower-margined dedicated accounts.
As such, total capital expenditures (capex) for 2020 are expected to run below historical equipment replacement levels. Management guided capex to run in the $20 million to $30 million range for 2020, which includes the proceeds from the sale of two real estate transactions. This is as much as half of what the carrier has spent in past years. With the reduction in spending, the average tractor age is expected to increase to 2.2 to 2.3 years by year end compared to the 2-year average reported at the end of 2019.
Parker said that so far in January, a good portion of Covenant’s business is up year-over-year, with dedicated “growing pretty fast.” He believes that pricing in its highway services business “bottomed out,” but said that the company is not asking for rate increases yet. Parker said that truck capacity is leaving the market and that they aren’t “being bombarded” for rate decreases anymore.
However, average revenue-per-mile metrics will likely be down in the first quarter, but not nearly as bad as the 11% year-over-year decline witnessed in the fourth quarter. In the recent period, rates from Covenant’s non peak season core customers were down approximately 5% to 6%. Along those lines, the first quarter is not likely to be profitable and management said that earnings will be second-half loaded in 2020.
Parker was enthusiastic about recent customer meetings. He said that the company is up for many new opportunities in expedited, brokerage and dedicated and that the three-day trip provided the most constructive talks he has experienced in 14 months.