With Quiver Quantitative’s recent institutional holdings data, we can see that many hedge funds and asset managers have recently increased their stake in Old Dominion Freight Lines Inc. (NASDAQ: ODFL). Firms such as Fidelity Investments, Renaissance Technologies, and asset manager Lord, Abbett & Co. have all added to their ODFL positions recently. Most notably, Renaissance Technologies increased shares held by 306% (as filed on 03/31), bringing their total ODFL holdings to 196,112 shares worth around $83.8 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 Old Dominion Freight Lines.
Yellow Corporation, one of the largest players in the trucking industry, is shutting down and declaring bankruptcy after years of gross mismanagement, leading to an interesting scenario within the trucking industry. According to Satish Jindel, President of transportation and logistics firm SJ Consulting, Yellow Corporation handled 49,000 shipments per day in 2022, with estimates that that number is down to 10,000 - 15,000 daily shipments. It is believed that Yellow Corporation’s exit from the trucking industry, historically one of the lowest cost carriers, will cause an upward shift in prices. Other LTL (Less-than-truckload) carriers will handle the customer diversion from Yellow Corporation at a cost, leaving an opportunity for other players in the industry. Old Dominion Freight Lines is a major player within the national less-than-truckload services industry, giving the company ample opportunity to benefit from the bankruptcy of one of its competitors.
Old Dominion Freight Lines Inc. (NASDAQ: ODFL) is one of the largest LTL (less-than-truckload) carriers in the United States. Founded in 1934 and headquartered in Thomasville, North Carolina, the business provides regional, inter-regional, and national LTL services, which are provided through an extensive network of service centers located around the continental United States. Historically, around 98% of the business’ revenue has come from LTL transportation, however, the business also offers value-add services such as container drayage, truckload brokerage, and supply chain consulting. With such a large portion of revenue coming from LTL transportation, it is important to consider the fact that Old Dominion’s LTL customer demand is largely tied to industrial production and the overall health of the U.S. domestic economy. This makes Old Dominion a relatively cyclical business, however, with improving macroeconomic conditions and seemingly increased consumer confidence in the U.S. economy, Old Dominion will likely benefit from economic tailwinds as the U.S. economy improves and comes out of its inflationary post-Covid state.
Old Dominion Freight Lines operates within the trucking industry, which serves virtually every industry operating within the United States with higher levels of reliability and faster transit times compared to other surface transportation options. The industry is largely composed of truckload and LTL (less-than-truckload) motor carriers. LTL carriers typically pick up multiple shipments from multiple customers on a single truck, whereas truckload carriers usually dedicate one truck to one customer from origin to destination. In 2021, the LTL industry had revenue of around $46.8 billion dollars, a highly competitive industry that has consolidated since the industry was regulated in the 1980s. Because of this, the largest 10 LTL carriers make up 82% of the domestic LTL market as of 2021. The trucking industry is one that is subject to government regulation, regulated by the DOT (Department of Transportation) and other state and federal agencies. The industry is often in the “cross-fire” of regulatory and legislative bodies addressing matters such as environmental regulations, vehicle weight limits, and driver hours of service.
The transportation and logistics industry is highly fragmented, with Old Dominion Freight Lines competing with regional, inter-regional, and national LTL carriers. Additionally, the business competes with truckload carriers, small package carriers, air freight carriers, and railroads. Management acknowledges that competition in the industry is largely based on service, price, capacity, and business relationships. Because of this, Old Dominion Freight Lines focuses heavily on customer service, minimizing cargo claims and maximizing on-time performance. Management believes that Old Dominion’s transit times are more reliable and faster than any of their principal national competitors. Additionally, the business’ large geographic coverage beats out regional competitors. The company’s diversified mix of regional, inter-regional, and national LTL service gives it a strong competitive advantage over most of the business’ competitors.
Revenue is mainly generated from customers throughout the United States and North America. For the last two fiscal years, around 95% of revenue was generated by services provided in the United States, with the remaining 5% of revenue being generated by services provided internationally. In 2022, Old Dominion’s largest customer made up 5.4% of their revenue, with their largest 20 customers making up 31.1% of their revenue. With a diverse customer base, Old Dominion protects itself from the reduction or loss of business from a single customer and hedges their risk to adverse developments in a single geographic region (i.e. new entrants to a particular geographic region).
Old Dominion competes for business via bid solicitations. Old Dominion’s customers will solicit bids for large numbers of shipments over a period of one to two years, entering contractual arrangements with a select few carriers based on price and service. This industry dynamic can cause some cyclicality in revenue if a specific carrier falls out of favor of customers due to poor pricing and service, however, Old Dominion has proven to offer best-in-class service and pricing, largely mitigating this risk. Additionally, Old Dominion and the rest of the trucking industry in general are subject to seasonal trends in tonnage level and revenue mix. Old Dominion’s revenue and operating margins are typically lower in the first and fourth quarters due to reduced shipment volume in winter months.
Insurance and diesel fuel are two massive operating expenses that Old Dominion incurs. To ensure diesel fuel availability, the business maintains and operates fuel storage and pumping facilities to fuel their large fleet, in addition to over-the-road fueling options at retail locations. In terms of insurance, the company periodically reviews their risk exposure and insurance coverage to ensure sound insurance of their fleet and other risks (cyber, casualty, etc.) While these are both large operational costs that aren’t exactly hedged to price fluctuation risk (i.e. diesel pricing), they aren’t unique to Old Dominion and the rest of the trucking industry is highly prone to these costs as well. Management believes they have just as much risk to these factors as other competitors, so while it isn’t a risk unique to the company, it is still something to consider when investing into a trucking company.
Management is solid and their capital allocation initiatives are shareholder friendly, with priorities to increase shareholder value through share buybacks and dividends. Additionally, management is also well incentivized, with a large majority of their salary being locked up in short and long-term performance-based incentives with objectives that focus on increasing the business’ market share and shareholder value. In 2022, Old Dominion repurchased $1.3 billion dollars worth of common stock and returned $134.5 million dollars to shareholders via a cash dividend. Old Dominion has increased their per share dividend by an average of around 35% since the inception of the dividend program in 2017. In terms of incentives, management is incentivized to grow market share and shareholder value, like mentioned above. To put everything into perspective, in 2022, the company's executive compensation plan allocated 8% of direct total compensation to non-performance based pay, with 74% of the direct total compensation going towards a performance-based cash incentive and 18% going towards a performance-based stock incentive. While we would like to see a larger chunk of that direct total pay go towards performance-based stock incentives (it can be said that performance-based cash incentives lead executives to focus on short-term incentives, which can lead to less retention / loyalty), we believe this is still a solid executive incentive plan that focuses on shareholder value and increasing market share, all while incentivizing management to not take on big risks.
Management also owns around 13% of the company, a relatively large sum that can show confidence from management and the board. Most notably, David S. Congdon, Executive Chairman of the Board of Directors, holds a 5.5% stake in the company, worth around $2.5 billion dollars at current market prices. It is important to note that David Congdon is the grandson of Earl Congdon Sr. and Lillian Congdon, who founded the company in 1934. Family ownership is a very overlooked characteristic by many investors, however, legacy is very important. People care about legacy and executives that come from the founding family are often very successful in their roles as they have a deeper understanding of the business than anyone else.
Old Dominion Freight Lines is a very efficient business. It operates at a ROIC of 43.5% and a ROE of 34.6%. With a WACC of 10.7%, the business operates at a ROIC to WACC ratio of around 4x, showing the business’ ability to generate returns far higher than its cost of capital. With such an efficient business, Old Dominion Freight Lines is able to reinvest cash back into the business at favorable rates of return, rapidly compounding intrinsic value and handsomely rewarding shareholders.
Analyzing Old Dominion Freight Lines’ income statement, we can see stellar sustained growth in revenue, gross profit, and earnings. Since 2013, revenues have grown at a CAGR of around 10%, with gross profit growing at a CAGR of 14% in that same time period. This growth in gross profit within this decade can largely be attributed to expanding gross margins. In 2013, the business operated with gross margins of 27.4%, compared to today where gross margins sit at around 40% on a LTM basis. In terms of earnings, EBITDA has grown at a CAGR of around 16% since 2013, with EPS growing at a CAGR of 22% in the same time period.
Looking at Old Dominion Freight Lines’ balance sheet, we can see that the company is in good financial health. The business has around $55 million dollars worth of cash and equivalents on hand, compared to long-term debt of around $60 million dollars. This is a very manageable cash to long-term debt ratio, showing the long term health of the business. In addition to this, the business operates at a 2.1% total debt / equity ratio, showing management’s conservative financial approach. Another important metric to consider is share buybacks, and management has proven to consistently buy back shares, returning value to shareholders. Share outstanding stood at 129.25 million shares in 2013, compared to today where they sit at 109.52 million shares outstanding, a 15% decrease in shares outstanding over the last decade. These share buybacks can explain the abnormally large CAGR in EPS compared to EBITDA within the same time frame.
Looking at Old Dominion Freight Lines’ cash flow statement, we can see stellar growth in free cash flow and net income, showing the operational efficiency of the business. Since 2013, net income has grown at a CAGR of 21%, with free cash flow growing at a CAGR of 32.5% in the same time frame. This large growth in free cash flow over the last decade can largely be attributed to expanding free cash flow margins. In 2013, free cash flow margins made up 2.4% of revenue, compared to today where free cash flow margins (on a LTM basis) make up 14.6% of revenue. As we can see, Old Dominion Freight Lines operates a durable business model that has become increasingly more efficient from an operational standpoint over the last few years.
After conducting a reverse discounted cash flow (DCF) model analysis, we can see that Old Dominion Freight Lines is trading at share prices that imply a 22.25% growth rate 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%. While Old Dominion Freight Lines is a high quality business, this growth rate is very high and shows that the company is trading at an expensive valuation. Since 2013, free cash flow has grown at a CAGR of 32.5%, which at first may make the 22.25% growth rate in free cash flows cheap, however, we are uncertain as to whether this is a sustainable growth rate for Old Dominion’s free cash flow. The 32.5% CAGR in free cash flow over the last decade can largely be attributed to expanding free cash flow margins. If Old Dominion Freight Lines is able to incrementally expand their free cash flow margins over the next 10 years and continue to grow free cash flow at a high growth rate, then this valuation may seem cheap in hindsight.