With Quiver Quantitative’s recent institutional holdings data, we can see that many hedge funds and asset managers have been increasing their holdings in Landstar System Inc. (NASDAQ: LSTR). Firms such as Victory Capital Management, Copeland Capital Management, and JPMorgan Chase have all added to their LSTR positions recently. Most notably, Victory Capital Management increased shares held by 2.57% (as filed on 6/30), bringing their total LSTR holdings to 1,549,559 shares worth nearly $292 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Landstar System Inc.
In July, Landstar System Inc. reported second quarter earnings results for fiscal year 2023. Landstar reported diluted EPS of $1.85 dollars per share in the second quarter, with second quarter revenue coming in at around $1.374 billion dollars. This is compared to the second quarter of fiscal year 2022, where the business reported diluted EPS of $3.05 dollars per share and revenue of $1.975 billion dollars. While these second quarter earnings results may pale in comparison to the same quarter last year, it must be noted that this year was a tough year for the freight industry, and these earnings exceeded consensus estimates. On a more positive note, the business operated at a ROIC of 34% during the quarter and announced that the company is currently authorized to repurchase up to 2.9 million shares of common stock under the current share repurchase program, showcasing the business’ superb capital allocation priorities. Additionally, Landstar announced a $0.33 per share quarterly dividend for the second quarter, a 10% increase from the $0.3 per share quarterly dividend paid out in the last 4 quarters, with Landstar acknowledging that they plan to continue to pay dividends on a quarterly basis going forward. With these strong earnings results in mind, we believe that Landstar System Inc. is a compelling investment opportunity currently trading at a very fair valuation.
Landstar System Inc. is a technology-enabled, worldwide, asset-light provider of integrated transportation management solutions, offering safe, specialized transportation services to a wide range of customers utilizing a network of third party capacity providers, employees, and agents. Landstar offers services to their customers across multiple transportation modes, and the business primarily operates in the United States, Mexico, Canada, and other countries around the world. The business markets its transportation management solutions through independent commission-based sales agents who enter into contractual agreements with Landstar to source and coordinate the transportation of freight with the business’ capacity providers. Landstar operates in two segments that include transportation logistics and insurance.
Landstar primarily competes in the transportation and logistics services industry with third party logistic companies, digital freight brokers, truckload carriers, intermodal transportation and logistics service providers, LTL (less-than-truckload) truckload carriers, railroads, and other asset-light transportation and logistic service providers. Management acknowledges that this industry is competitive and highly fragmented. Management also acknowledges that competitive factors within this industry include service, efficiency, and freight rates, which are highly influenced by economic conditions (making this a cyclical business). Some of these economic conditions include industry-based factors, such as available transportation capacity and freight demand. While the industry is highly competitive, management believes they hold a strong competitive advantage in the industry, based on the business’ size, service offerings, wide range of equipment, and its geographically diversified footprint of its independent agent network.
Management is solid, and their capital allocation priorities do a good job of aligning shareholder and management interests. Management has been aggressively repurchasing shares over the last decade. Since 2013, shares outstanding have fallen by around 21% since 2013, with management repurchasing over 5 million shares in that time frame. In addition to share repurchases, Landstar also pays out dividends. With a payout ratio of 34%, Landstar distributed around 34% of its earnings in the form of dividends. This ratio of 34% is great, as it allows the business to payout a large portion of their earnings to investors, while also being a small enough portion of earnings to allow the business to compound over a long-term time horizon. These initiatives to repurchase shares and offer quarterly dividends do a great job of creating value for shareholders, making Landstar System Inc. a shareholder friendly company to invest in.
Additionally, in terms of management incentives, Landstar imposes a compensation structure on executive leadership and NEOs that does a good job of aligning shareholder and management interests, while also doing a great job of retaining long-term executive talent. The compensation structure includes a base salary and performance-based compensation programs. These programs include an annual incentive compensation program and stock based rewards (RSU and and special RSUs). Not only does the compensation structure reward management for good performance (based on predetermined metrics important to the business, like diluted earnings per share) it also retains talent over the long-term and aligns shareholder and management interests well as management builds ownership in the business through equity rewards. As management continues to build equity in the business, they are much more incentivized to perform well (and ensure that shares perform good as well), as vested stock units are a large part of their total compensation. As an investor, it is always good to invest in a business where management feels like a “partner” alongside shareholders, and we believe that Landstar is a perfect example of this.
Landstar System Inc. is a very efficient business. The business currently operates at a LTM ROE of 36.6% and a LTM ROIC of 37.6%. With a WACC of 9.1%, Landstar currently operates at a ROIC to WACC ratio of around 4.1x, showcasing the business’ ability to generate returns on cash reinvested back into the business at rates of return far greater than their cost of capital. With such a high ROIC to WACC ratio, Landstar System Inc. is able to rapidly compound its intrinsic value over the long-term (assuming that ROIC figures stay flat or expand over time), handsomely rewarding shareholders. Looking further at efficiency metrics, we can see that ROIC has expanded over time, potentially signaling that the business’ holds a stronger competitive advantage / moat within the industry that they operate in. In 2013, Landstar System Inc. operated with a ROIC of 27.7%, compared to today where the business operates at a LTM ROIC of 37.6%.
Analyzing Landstar System’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Landstar has grown revenue at a CAGR of around 8.15%, with gross profit growing at a CAGR of 8% in that same time frame. Looking at margins, gross margins have remained relatively flat over the last decade, hovering around 20-22%. In terms of earnings, Landstar has grown EBITDA at a CAGR of 8.7% since 2013, with EPS growing at a CAGR of around 10.4% in that same time period. The growth in EPS relative to EBITDA can largely be explained by share repurchases. Landstar is a cannibal, decreasing shares outstanding by 21% since 2013.
Looking at Landstar System’s balance sheet, we can see that the business operates in sound financial health. The business currently holds around $360.5 million dollars worth of cash and equivalents on hand, with $58.5 million dollars worth of short term investments bringing total cash and short term investment holdings to $419 million dollars. Additionally, Landstar holds around $57 million dollars worth of short term borrowings on their balance sheet, but no long-term debt, showcasing the business’ strong balance sheet. With a net debt of $-275.4 million dollars, Landstar System’s has $275 million more dollars of cash than debt on their balance sheet, meaning that they have plenty of runway to pay off their current debt obligations. Additionally, with so much excess cash, the business can use it to repurchase more shares, offer / increase a dividend, or reinvest it back into the business at high rates of return, rapidly compounding the business’ intrinsic value.
Looking at Landstar System’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow, showcasing the business’ operational efficiency. Since 2013, Landstar has grown net income at a CAGR of around 8%, with free cash flow growing at a CAGR of 12.6% in that same time frame. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2013, the business operated with a free cash flow margin of 5.8% of revenue, compared to today where the business operates at LTM free cash flow margin of 9.1% of revenue. As free cash flow margins expand, the business is able to generate more cash from revenue. This cash can be used for further share repurchases, quarterly dividend increases, or reinvests back into the business, all of which help the business rapidly compound over time, handsomely rewarding shareholders.
After conducting a reverse discounted cash flow analysis, we can see that Landstar System Inc. is trading at share prices that imply a -0.1% growth rate (CAGR) in free cash flow over the next 10 years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. This growth rate essentially implies no growth in free cash flow over the next 10 years, and while that is a very cheap valuation in the long-term, in the short-term, it makes sense. The freight industry has had a tough stretch since 2021, with freight volume declining as the economy weakened throughout 2022 and into 2023. So while in the short-term this valuation makes sense, if you are a long-term investor looking to hold for 3-5+ years, this valuation is extremely cheap. Over the last 10 years, Landstar grew free cash flow at a CAGR of 12.6%, and while past performance is not indicative of future results, Landstar also expanded their free cash flow margin handsomely within the last decade. The free cash flow margin will act as a catalyst for future free cash flow generation, and if the business is able to expand this free cash flow margin, this valuation is a steal for a long-term investor. Additionally, it is also important to notice that valuations have regressed because of the business’ inherent exposure to the broader U.S. Economy (as mentioned above, this is a cyclical industry). With macroeconomic conditions improving, and as consumer spending starts to tick back up, the transportation industry will benefit from tailwinds as the U.S. economy starts to come out of its post-Covid inflationary state, acting as a further catalyst for future free cash flow generation.
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