I am a little late getting this analysis of Old Dominion (Nasdaq: ODFL) up, but I hope it is better late than never. ODFL is a stock I owned (profitably) years ago and still like to follow - I think it is hands down the best less-than-truckload (LTL) carrier out there. Nevertheless, being the best in your business does not necessarily mean the stock is worth buying.
It was a solid second quarter for ODFL. Revenue rose 16.5% to 368M, and handily beat the estimate of $359 million. This revenue was produced by a nice increase in tonnage (up over 13%), offset by a decline in fuel-adjusted pricing (down about 1%). That weak pricing environment is one of the big worries in this space - although ODFL has not matched smaller rivals in taking bad pricing just to keep the trucks running, they have not been able to escape it all together.
Where ODFL really shined this quarter was in its cost control. The company's operating ratio (basically the opposite of operating margin) improved more than 400 bp to 89.1%. Lower non-cash charges (mainly depreciation) helped a lot, but the company also saw quite a bit of improvement by holding down wage growth and compensation costs.
Management was a bit cautious about the second half of this year, and given the economic news that has come out this week that seems reasonable. I am not sure that LTL carriers like Old Dominion are any better "tells" on the economy than truckload carriers like Knight (NYSE: KNX) or Heartland Express (Nasdaq: HTLD), but it stands to reason that LTL would be tied more closely to the tenor of small business (since they cannot afford to send out whole truckloads at a time). Either way, I would not be surprised to see continued pricing weakness this year, though weakness in tonnage would definitely be a bad sign for the economy.
Trying to value Old Dominion and assess its future is pretty tricky. The company has spent most of the last decade building up its business. It takes somewhere around 250 - 300 service centers to operate a national LTL business, and Old Dominion started the year with about 210. So even though ODFL will always have to spend on new equipment (trucks, trailers, etc.), the big build-out is close to an end. That means cash flow leverage.
Also, even though ODFL is a rather efficient operator in the LTL space, they are not the top in all metrics. Rival Con-Way (NYSE: CNW) seems to produce considerably more revenue per service center than ODFL (about 2.5 to 1). Now, ODFL is ahead of the likes of Arkansas Best (Nasdaq: ABFS) and there may be idiosyncrasies with Con-Way that make a straight-up comparison misleading, but it still seems to me that ODFL can (and should) get more leverage out of their infrastructure. If they do that ... more cash flow.
So, all of that being said, I still run into a wall when it comes to evaluating ODFL on a cash flow basis. Even allowing for significant free cash flow leverage (free cash flow margin moving from a historical level of -3% to 6% over five years, with above-trend growth in the five years after that as well), I get a DCF-derived price that is about 10% below today's level. Turning to an alternative methodology, forward EV/EBITDA valuation, I get a target of $45.50 (using a 7x forward multiple). That is certainly better, but still not enough to excite me.
All in all then, Old Dominion is a good company that is priced like one. I might be interested if it pulled back 10-20%, but there is just not enough potential here to get me to buy.
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