ODFL - Old Dominion Freight: Perfection At A Premium Price

2023-08-17 14:58:30 ET

Summary

• Old Dominion Freight Line is a highly successful trucking company with a strong competitive edge in the industry.
• The company's superior service and efficient operations have allowed it to gain market share and achieve impressive revenue growth.
• However, economic headwinds and a high valuation have led me to remain on the sidelines and wait for a better buying opportunity.

Introduction

Way before I started sharing my investment thoughts on Seeking Alpha and social media, my Achilles heel was buying overcrowded investments. Like most beginning investors, I felt a strong confirmation basis when I invested in something that everybody liked. After all, it can't be bad when everyone owns it. Right?

Now, I'm doing the opposite.

Whenever an investment becomes crowded, I tend to stay away. While I'm very happy with my timing since I changed my view, I do tend to miss some high-flying stocks every now and then.

One of these investments is Old Dominion Freight Line ( ODFL ) , sometimes referred to as OD.

I've had this company on my radar for many years and frequently discussed why it's the best trucking company in its industry.

Over the past ten years, ODFL has returned 1,300%, beating the market by a margin that can be seen from space.

The reason why I'm not an ODFL shareholder is because of my view on the economy. Economic growth is not fine, and the company's numbers reflect that.

However, with the bankruptcy of Yellow (formerly trading under the YELL ticker), investors are frontrunning a situation where ODFL benefits from higher cyclical and secular growth down the road.

In this article, we'll discuss all of this, including my plans to remain on the sidelines.

Simply The Best

Sometimes, there's a thin line between clickbait and reality. However, when I say that some stocks are the best in their industries, I mean it.

Generally speaking, I don't like the trucking industry. While I love to monitor its data and incorporate comments into my long-term macroeconomic outlook, I am not a fan of buying stocks in industries with low entry barriers and low margins.

Trucking is one of the most competitive industries in the world and is prone to severe demand swings, labor dynamics, energy prices, weather, and so much more.

What makes ODFL so special is its ability to find a competitive edge in this environment. After all, the benefit of operating in an environment with low entry barriers is that high-quality companies can gain market share rather easily.

The company has invested aggressively in service centers and made customer satisfaction the core of everything it does.

ODFL currently operates 256 service centers in 48 states with connections to both Canada and Mexico. Its routes are serviced by more than 11,400 trucks, making it the second-largest LTL (less than truckload) operator with a market share of 12%.

In 2022, the company had a 2.9% market share, which shows how powerful this company has become.

The main driver is its superior service. The competitive value map shows that the company has a superior service, which provides it with more pricing power without becoming too expensive. Or, to put it differently, customers value better service.

The company's superior service can be summarized by a few key numbers:

• The on-time ratio has improved from 94% in 2002 to 99% in 2022.
• The cargo claims ratio has declined from 1.5% in 2002 to just 0.1% in 2022.
• The company has won the Mastio Quality Award 13 years in a row.

As a result, the company was able to grow its revenue by 12.8% per year between 2002 and 2022 - almost entirely organically (without M&A).

Furthermore, to visualize how efficient this company is, the chart below shows both revenue per service center and the operating ratio.

Since the pricing benefits of the pandemic, the company was able to push its operating ratio into the low 70% range, which makes it the most efficient LTL operator in its industry - by a wide margin.

Even better, most Class I railroads (known for their efficiency) are currently dealing with ORs in the mid-60% range, which shows just how efficient this trucking company is.

Having said that, let's take a look at recent developments.

Economic Headwinds Are Building

The good times are over.

An indicator I often use to assess economic trends is the ISM Manufacturing Index. This indicator has been in contraction territory for nine consecutive months. The index peaked in mid-2021. Since then, cyclical stocks have had a hard time on the stock market.

Looking at the Logistics Managers' Index below, we see a confirmation. The LMT has been in a steady downtrend since early 2022. In July, the index hit a new low at 45.4.

According to the LMI survey :

Large carriers did not escape July unscathed. It was a year ago in July 2022 that Transportation Prices shifted into contraction territory. Transportation Prices have continued to contract ever since this pivot reading in at 35.6 (+2.8) in July 2023. Transportation Utilization also contracted (-5.0) at a rate of 41.8. The consequences more than a year-long freight recession were felt acutely this month. Yellow, America's third-largest LTL carrier shuttered operations on July 30th. This move jeopardizes around 30,000 jobs and would be the largest trucking company collapse in U.S. history. Yellow is not the only carrier having a rough go financially. Knight-Swift reported a 21% drop in revenue during Q2. Many other carriers, including Saia, Hub Group, and Ryder were down in the second quarter.

During the company's 2Q23 earnings call, the question was raised whether ODFL could potentially serve as a relief option for Yellow's customers due to its reputation for higher-priced, high-quality service.

While the company didn't provide a definitive answer, it emphasized that it is engaged with its customers, showcasing its capacity and service capabilities.

The company also drew a parallel to its response during the rapid freight increase in 2021, highlighting a commitment to protecting existing customers' capacity while being prepared for potential shifts in the industry.

Essentially, this means that the company will likely benefit. However, it isn't willing to give us more details. That makes sense, as it could raise high hopes with a significant risk of underdelivering.

Speaking of being able to take on more (potential volume), as of 2Q23, the company had roughly 30% excess capacity within the service center network, slightly surpassing the 25% target range.

This was the result of the aforementioned economic challenges.

The second quarter saw a 14.1% decrease in LTL tons per day and a 1.1% decrease in LTL revenue per hundredweight.

This decline in revenue was influenced by a significant drop in diesel fuel prices during the quarter.

However, despite these challenges, the company managed to achieve a 7.6% increase in LTL revenue per hundredweight, excluding fuel surcharges.

This increase demonstrated Old Dominion's consistent approach to yield management, which would not have been possible without superior service quality.

Going beyond the second quarter, July's revenue trends aligned more closely with historical averages, potentially marking a shift from earlier in the year, according to the company.

The month's revenue per day was down roughly 15% to 16% compared to July 2022.

This drop could be attributed in part to the timing of the July 4 holiday. If recent workday trends persist, it is anticipated that the sequential change in both revenue and shipments per day for July will align more closely with the 10-year average.

Despite these headwinds, the company is confident, as a new $3 billion share repurchase program has been approved by the Board. This new program will follow the completion of the existing $2 billion repurchase program announced in July 2021.

The new buyback program is roughly 7% of the current market cap.

Over the past ten years, ODFL has bought back 15% of its shares.

Also, bear in mind that the company has negative net debt, meaning it has more cash than gross debt. So, even economic challenges don't pose a serious threat to buybacks as long as the company is generating free cash flow.

Valuation

Due to the mix of slower economic growth with potential contraction down the road and the company's 40% year-to-date stock price surge, we're dealing with a 23.4x NTM EBITDA multiple.

The consensus price target is $409, which is 2% above the current price.

In light of economic challenges, I'll keep doing what I've done so far: staying on the sidelines.

I believe that a cyclical company like ODFL needs to be bought at a great valuation - even if it means that I might miss more upside.

If (not when) ODFL gets close to $340, I might become a buyer.

Given the economic situation and the stock price surge related to the YELL bankruptcy and hopes of rebounding economic growth, I will maintain a Hold rating.

Takeaway

Despite ODFL's resilience and strategic positioning, the uncertain economic landscape causes me to stay on the sidelines. I'll continue to wait for the right valuation before considering a potential investment.

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