|Shares Out. (in M):||85||P/E||0||0|
|Market Cap (in $M):||5,346||P/FCF||0||0|
|Net Debt (in $M):||122||EBIT||0||0|
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Please see attached for the same, with some charts: https://www.dropbox.com/s/5eotrcwh3vnlpzg/ODFL%20-%20quick%20writeup.pdf?dl=0
“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.” – Charlie Munger
Thesis: Old Dominion isn’t a particularly cheap stock at $63 (11x EBIT) and has bounced back 20% since the recent lows. However, in contemplation of high quality businesses that win disproportionately in downturns, we think ODFL is an attractive stock to own in this environment for the next 5+ years. The premise is on #1) by far the best operator with a persistent margin advantage due to network density, #2) 20 year history of 20% ROIC with all the FCF reinvested, and a long runway to continue reinvesting in the moat, and #3) management with a strong understanding of capital allocation
Old Dominion Freight Lines is the largest pure play less-than-truckload (LTL) carrier in the United States. It is the #4 player with 8% market share of a $50 billion market, with a medium term goal is to achieve a low teens market share. Unlike TL, LTL carriers consolidate small shipments from many customers in order to maximize trailer utilization and is inherently very logistics intensive. As the business is inherently regional, a company with leading density will have a persistent moat in its economies of scale (Network density is the prevailing driver of high returns). ODFL is by far the best operator, with margins approaching 20%, >99% on time rate, and
Truckload shipping is a highly competitive business with low barriers to entry. Anybody with a truck and a license can pick up a full trailer at one location and drive it to another. LTL shipping is entirely different. It is a highly capital intensive, fixed cost business. LTL shippers must maintain a network of local service centers, which are responsible for the pickup and delivery of freight within their service area. Each night, these service centers load outbound freight for transport to other service centers for local delivery.
Therefore, route density is critical in LTL shipping. The cost per ton shipped decreases as more tons are shipped through a given service center. And the closer the customers that will fill a truck are to one another, the cheaper it will be to fill that truck. This leads to a self-reinforcing effect whereby the dominant LTL shipper in a region has the lowest cost per ton, and therefore can price lower than competitors. Therefore, the dominant LTL shipper gets larger and more dominant over time.
The American Trucking Association reports $47 billion LTL, of which top 10 players control $31 billion. The largest five competitors are: Fedex, Con-way, YRC, Old Dominion, UPS. Pricing fell >20% from 2007 to 2009 (Fedex and Con-way tried to price YRC into bankruptcy), and has only recently returned to pre-recession levels. It appears, however, with the impressive pullback across the trucking industry, that rates may be somewhat unpredictable over the next year.
Management is prudent and act as owner operators (the Congdon family owns 25% of the Company). The company has always minimized the use of leverage (net debt has never exceeded 1.8x in the history of the business), they are conservative in adjusting out “one-time items” (did not adjust out an idiosyncratic negative injury until probed about it), and are very thoughtful capital allocators (Q2’2014 call: “Yes, another point is, as we look at asset light type acquisitions and companies of any size, it appears to us that the marketplace has overpriced a lot of these companies that some of the multiples of EBITDA that companies are paying, and the private equity firms are paying tend to price us out of the market. And we're also a bit constrained by our own success. The fact that we're earning greater than 15% return on invested capital, if we plug that expectation into an acquisition, we might only come up with 3x to 4x EBITDA, and think we're paying 8x to 10x EBITDA.”). The Company repeatedly emphasizes that each load needs to meet the Company’s internal return criteria on a standalone basis. Philosophy has not wavered for the past 10 years (even through the Great Recession)
ODFL switched from building out/acquiring platforms and has allowed its service centers to mature, as seen by the $4 million revenue per service center to $13 million in 2015 (service center numbers estimated to be flat YoY)
[chart of service centers and revenue/service center]
[chart of ltl tonnage, yield]
The Company’s density advantage against peers can be seen in the following charts:
[operating ratio comparison]
(competitor average includes: Fedex Freight, SAIA, Con-way, YRC Freight, and ABF Freight)
Between 2005-2008, the Company’s operating margins stagnated due to choice:
“What we're still striving to do is to build earnings per share and we are doing it by driving the top line at a pretty fast rate and it's giving us a great increase in earnings per share but it is not a strategy that will cause the operating ratio to plummet. Best way to get that down is to slow down the geographic expansion and we could show some rather quick reduction in the operating ratio but I believe that our earnings per share increase would be less.” – 2005, David Congdon
This transition began to occur when ODFL decided to focus on maturing its asset base (transition from network build to density build): “Ed, well, I think you can look at some of the other carriers who have as much as 30 to 40% higher revenue per service center than we do that have operating ratios in the 85 to 88 range. So you would think that as we build our density per terminal -- I guess we are a little north of 6 million per service center now, and some of these other carriers, if you look at them, they are north of 8 million.”
[cost breakouts vs competitors]
[operating ratio vs competitors]
Outside YRC and ARCB, who will always be at a competitive disadvantage due to a large unionized employee base (~10% higher employee costs), ODFL margin delta comes largely as a result of a ~10%+ lower base of purchased transportation. ODFL overinvests in capex in order to make sure it has density in its own networks, and relies on 3rd party brokers to “fill in” all the capacity, as opposed to competitors who tend to purchase external transportation to supplement a smaller, less dense network. As a result, the Company has industry leading revenue (ex purchased transport, which is basically a pass through) per service center versus competitors, as well as the highest tonnage/employee. This allows the Company to earn a decent ROIC, but without ripping off customers:
““…So when we go to price an account because we're so efficient, the price that we charge is fair and perceived as a darn good value in the market, because we don't have to charge as much as anybody else does that doesn't operate as efficiently, and still achieve the results that we are looking for” –Q2’2015 (David Congdon)”
Also, roughly half the business ODFL operates is contracted – these are generally less profitable contracts with large national accounts. However, this business serves as the “base load,” allowing mom and pop shipments to be very profitable on an incremental basis. A new competitor would find it difficult to win large national accounts, and hence would not be able to create this “base load.” Without it, new competitors would not be competitive on cost or density
Valuation: Old Dominion currently trades at 11x EBIT, and the valuation has historically been driven by increase in earnings, not on any form of multiple expansion:
(the P/E chart looks the same, 20x and 18x current respectively).
The Company doesn’t look “cheap” with multiples at a small discount to long term averages, but the stock has also gone up 6x during that time (and has always traded at this multiple). Margins likely don’t have much more room to rise (as they are approaching incremental margins), but most competitors are still earning low to mid single digit operating margins and a downturn would drive them easily into the non-profitable zone. Hence, I think ~15% margins are sustainable long term.
More importantly, the Company has only 8% market share and believes there is significant room for continued tonnage growth at the historical (20%) ROIC. A low teens market share target will give 5-10 years of reinvestment opportunity. The Company has already guided to ~$440 million of capex for 2016, just shy of the $460 million spent in 2015.
[ROIC over 20 years]
As Munger states, a company that can reinvest at high ROICs for the long term will see returns approximate ROIC. At today’s price, an investor would be getting a ~5.6% earnings yield, but has the opportunity to reinvest much of that at 20%+ returns. That kind of cash flow is worth probably 14x EBIT today. Alternatively, we believe you can also purchase the stock and sit on mid to high double digit IRRs over the next 5 years.
We don't enter a recession and rates strengthen, or we do, and ODFL gains more share at the bottom
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