Sometimes, less is more. This is certainly the case in trucking where the enviable industry dynamics in ‘Less-than-Truckload’ make the Truckload market look like the Wild West.
Old Dominion Freight has been one of the top-performing stocks in the S&P for the last two decades, posting a total return of 7000%+. Will the next act be just as impressive? Unlikely. However, comparison may be the thief of returns in this case as the coming decade should still be very fruitful for investors.
Since writing this report a few weeks ago I have read two contradictory pieces which offered interesting insight.
The first was a thoughtful paper discussing the nuance between Implicit and Explicit conviction. Explicit conviction is confidence in ‘the numbers’, which also implies conviction in the operating environment over your forecast period.
Implicit conviction is more akin to a form of trust. No matter the operating environment, or competitive challenge, you trust management to do the best thing.
Explicit conviction changes when conditions change, whereas Implicit conviction allows investors to look through an evolving environment.
The second was a podcast with Hamilton Helmer, the author of the wonderful book on competition, 7 Powers. The poignant line being;
”Waiting for your competition to make a mistake is not a strategy”
ODFL cleans up when others mess up, and this ‘strategy’ has worked. However, this story has been driven by diligent investments through the cycle and share gains in the premium end of the market.
The runway for share gains here is not as great as it once was, but I have implicit trust that management will continue to execute at a high level and allocate capital productively. Likely placing this back in the hands of investors.
Unfortunately, given where we are in the trucking cycle, the first leg of the recovery is already healthily priced in. I feel this is a name that should be firmly on your radar and I hope this report provides a thorough introduction.
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Company Overview
Old Dominion Freight (ODLF) is the second largest LTL (less-than-truckload) carrier in the US with ~13% market share. The company operates nationally through a single integrated, union-free organization across the US and extends operations into Canada and Mexico through strategic alliances.
LTL generates 98% of revenue, the rest comes from value-added services such as; container drayage, truckload brokerage, and supply chain consulting.
The company was founded in 1934 with just a single truck, fast forward to today and they operate across 48 states with;
· 260 Service centers
· 43 Maintenance centers
· 10,791 Tractors
· 31,233 Linehaul Trailers
· 15,181 Pickup & Delivery Trailers
Old Dominion picks cargo up in one location and puts it down in another. Simple. Whilst trucking might not be that sexy, ODFL has been one of the top-performing stocks in the S&P over the last two decades. They have far outperformed the index and their industry.
What is Less-than-Truckload
An LTL carrier typically handles packages between 100lb and 10,000lb, serving the so-called ‘tweener market’. Freight that is too bulky for the parcel (UPS/ DHL/ USPS, etc) and doesn’t hit the volume thresholds to fit a truckload.
LTL is a hub and spoke model that involves multiple pickups within a dense urban network which are then consolidated at a service center and organized by destination. This is called Pickup and Delivery (P&D) by ODFL. Freight is then reloaded onto ‘Line Haul’ trucks and transported to faraway service centers before being transferred onto P&D trucks again that drop the freight off at its intended destination. The network also contains breakbulk facilities, where goods shipped separately or coming in from different locations can be consolidated and shipped as one to a customer.
This differs from truckload which will typically dedicate an entire truck to one customer and transfer freight from point A to point B, not facilitating multiple pick-ups.
The LTL market caters mostly to industrial end market with some retail exposure.
Pricing in LTL is a function of; Distance, Weight, Speed, Class, and Accessories.
The industry tends to report revenue per hundredweight. This metric reports the price of freight per 100lb and confers some information about pricing more broadly and the mix of freight. There is some nuance here in that heavier shipments are often at a lower price-per-hundredweight because they allow trucks to hit their weight limit before they actually fill whereas lighter more voluminous freight comes with a premium price per hundredweight.
Financials
As you can expect based on the stock chart, financial performance has been impressive. Old Dominion showcases strong and consistent topline growth in an inherently cyclical industry. Layer on the magical effects of leverage and you can see how this growth is amplified down the income statement.
Growth has been driven by a MSD pricing CAGR and LSD volume CAGR. The company strives to take 100-150bps of price above inflation and has been a chronic share gainer. The pricing power is derived from industry-leading service quality which we will dive into in greater detail later. This additional volume is supported by steady investment in capacity expansions through the cycle.
Price and volume gains have driven operating leverage, the majority of which has stemmed from salaries and general operating supplies.
Interestingly, Old Dominion’s growth has been exclusively organic since 2008 and funded primarily through FCF. The company spends 10-15% of revenue in CAPEX annually through the cycle and invests ahead of growth in its service centers. Management always strives to have 20-25% spare service center capacity, this allows them to uphold a high-quality service and pick up share in good markets without compromising existing customers. This discipline and long-term approach to capital has been part of the company’s secret sauce which I will discuss in more detail later.
Between 2012 > 2022;
Service centers grew 17%
Doors (Service center capacity) grew 48%
Shipments per day 75%
Old Dominion has generated supreme leverage on its service center assets by expanding existing facilities with remarkable effect. When management acquires land they ensure there is ample room for profitable door expansion. This also de-risks reinvestment as they understand their assets, and the markets they are in and can expand incrementally with demand.
Since 2014 the company has employed ~$2.2B in CAPEX allocating ~45% toward service centers, ~45% to trucks & trailers, and ~10% on technology.
Combine self-funded growth with operating leverage and you get an appreciating ROIC that now sits at 20%. This will only increase as long as the company can continue to employ this strategy.
Capital allocation has migrated over the past decade from almost exclusively CAPEX to a more balanced approach where management now returns capital to shareholders through buybacks and dividends. I originally took this as a potential red flag on organic reinvestment opportunities but the CAPEX/Sales has been relatively steadfast in the 10-15% range. They are simply earning excess cash beyond their natural rate of organic reinvestment and are returning this to shareholders. This shows management’s ability to remain disciplined, stick to the model, and commitment to shareholders.
I will close this section by saying that Old Dominion is virtually debt-free and boasts a Total Debt / EBITDA ratio of 0.1x and it hasn’t risen above 0.3x in the last decade.
The LTL Market
The LTL industry had a total TAM of $53.8B in 2022 and comprises 7% of the total logistics market in the US by revenue but only accounts for 1% of volume.
I love this quote taken from another great LTL write-up by Sweet Stocks, it really captures the crucial nature of LTL and its stickiness in the market.
LTL is “viewed as something that you’d like to avoid, if possible. It’s relatively expensive compared to truckload and relatively slow compared to parcel, but it’s never gone away. It continues to fill a needed tweener gap in the market.” (Source: Tom Nightingale, CEO of AFS Logistics.)
The industry is highly concentrated;
The top 5 and 10 LTL carriers account for 56% and 81% market share respectively.
This compares very favorably with the fragmented Truckload market in which the top 20 carriers hold only 8% share and where 96% of fleets have fewer than 10 trucks.
ODLF sits firmly in second place behind the behemoth that is FedEx but they cater to very different customers. ODFL caters to quality-focused clients and FedEx would be a mass market player.
Companies compete on service, price, and available capacity.
What makes LTL so good?
LTL is a highly capital-intensive business. That creates significant barriers to entry. Firms need to invest heavily in real estate assets to build out this hub and spoke model that allows them to efficiently collect freight from many different customers.
Much of this real estate needs to be in dense urban areas which makes it very hard for new entrants to compete. It also means incumbents may have an irreplicable competitive advantage in certain markets.
Scale. As with any fixed asset business, scale is a potent barrier to entry. To earn a positive return on service center assets a new competitor would need sufficient volume in the network. LTL is a density game that requires a minimum efficient scale, this will lock out any new entrants to the market.
These barriers to entry and superior returns to scale have resulted in a highly concentrated industry that has consolidated even further over the last two decades. Before Yellow’s exit, the top 10 closures in the industry have driven $4.5b in revenues to the survivors since 1993. In recent years further consolidation has been driven by customers’ desire for national coverage and the superior leverage at national players allowing for greater reinvestment in growth.
All of the characteristics above have led to an industry that is rational on price. Every year carriers will institute a General Rate Increase (GRI) that will be relatively homogenous. The industry has posted positive pricing growth for over a decade, albeit against a relatively positive economic backdrop.
Above, I noted ODFLs consistent growth, this has come against the backdrop of contracting industry volumes. Capital cycle theory helps us understand how this reduction in investment has resulted in superior industry economics.
The other key industry dynamic has been the chronic share donation of the recently deceased low-cost carrier Yellow who fed volumes back into the market for 20 years.
Underlying volume growth in the industry is tied to industrial production which could be characterized as cyclical and anemic, failing to make material new highs in over 20 years.
Industry revenues have been largely driven by price, however, Yellow’s gradual demise has allowed the other carriers to grow volumes steadily.
Old Dominions ‘Secret Sauce’
Quality
ODFL has long sought to maximize on-time performance and minimize cargo claims. They have established themselves as a quality operator and cater to a subset of the market that values quality service over price. Over the past 20 years, through a relentless focus on service, they have improved both metrics beyond tangible improvement.
Old Dominion has ranked #1 in the Mastio Quality Survey for 14 straight years. This is a well-recognized industry survey that benchmarks different LTL carriers on a variety of metrics.
What is the price to a customer of low-quality service? Their industrial customers ship higher-value electronic components which are likely a cog in a larger machine so late / damaged goods could have material knock-on effects on production. Retailers face chargebacks for late goods. We also cannot understate the benefit of simply having things run on schedule. The bottom line, ODFL has proven that there is a corner of the market that will pay up for on-time delivery. For their end customers, the price of delivery is likely a small portion of the total costs which should infer some pricing power for carriers. This would be a good question for management.
Scale & Integration
As the second largest player ODFL can lever their fixed costs to greater effect, which allows Old Dominion to reinvest in capacity growth through the cycle. Certain customers also value national coverage and ODFL has long been able to offer this. Given the difficulty in procuring quality real estate, there is a potential that ODLF will be structurally advantaged in certain markets where they have an established footprint and it may be impossible for competitors to service the same market with equal profitability.
Old Dominion is fully integrated, owning 91% of its facilities and all of its line haul assets. This is a key differentiator with competitors. This has several benefits;
Control. Management asserts that ownership of line haul assets allows them to provide the high-quality service they deliver and this makes sense. Reliance on third-party transport removes control and allows for very little flexibility. Consistent on-time delivery requires harmonious operation of many different pieces, day after day.
Cost Advantage. Owning your line-haul assets may only make sense at a certain scale, as the #2 player I think ODFL certainly has the scale to lever these effectively. Interestingly, some competitors may be locked out of this competitive advantage if they don’t have the necessary density. There is also a longer-term leverage benefit to be achieved through ownership of your facilities although this plays out over 10-20 years. The clearest example would be the cost-benefit derived by Copart over competitor IAA as leases will re-rate to the market rate over time.
Flexibility. We have already seen the profitable effects of door expansion. Expanding doors could be difficult if you lease, if you need to move beyond your own space you would require the lot beside you to be free/fit for purpose. ODLF can expand incrementally with demand and engineer the entire facility to fit their needs.
Discipline
I spoke about this regarding capital allocation above but ODFL is also incredibly disciplined on yield. They will typically shed tonnage in a soft market to protect margins. Historically their market share gains have come in an upcycle where they will outgrow the market by 600-1000bps. This is a function of the 20-25% latent capacity Old Dominion maintains and the relatively lower levels of spare capacity held by competitors. So when competitors who run at higher utilization levels go out and chase volumes they inevitably compromise on service and disenfranchise certain customers who turn to ODLF.
Culture
One of the hardest factors to quantify in investing but certainly one of the most important. Logistics is ‘Conceptually simple but practically difficult’ - Source unknown.
I took this from an expert call a few years ago and thought it perfectly encapsulated the challenge of dealing with the many moving parts.
Old Dominion’s service levels are a testament to how this culture of excellence has permeated through the ranks. They also mention their low employee turnover and competitive pay for their industry. I do not have the stats on that but ODLF has trained 1/3 of their drivers.
LTL caters largely to SMB customers and relationships matter more here than in huge organizations where decision makers are likely far removed from the ground operations. Customers of Old Dominion have a single point of contact at their local service center and their employees are trained in multiple roles.
Switching costs for customers are not astronomical but they are not negligible. If a customer is happy with the service it would take a reasonable cost discount to convince them to switch. I think this is where a good working relationship could make LTL a sticky business for small businesses. I repeat again, relationships matter and these will be positively reinforced by excellent service.
Competition
Old Dominion has created a winning playbook and this has not gone unnoticed. Imitation is the sincerest form of flattery but also competition. The two copycats out there are Saia and XPO.
Saia
Saia is a smaller competitor with ~5-6% market share that has adopted the ODFL playbook. Through a series of acquisitions and ambitious CAPEX, they have established national coverage, likely setting the scene for further market share gains.
Saia has been steadily improving their claims ratio and targets the same 20-25% latent service center capacity as ODFL. The company has been able to execute on growth and generate 870bps of leverage on its operating ratio since 2013.
LTL is a great industry and I think Saia could be another great horse for investors to back.
XPO Logistics
XPO is a sizable threat with their new ‘LTL 2.0’ playbook that looks like a copy and paste from an ODFL investor day. David Bates, an ex-ODFL executive recently took up the COO position there and has started executing on the same initiatives.
Damage claims are down to 0.3% vs ~0.6% at Saia and 0.1% at ODFL. I question how important those final 20bps are for customers.
ArcBest
ArcBest is a high-cost Union carrier. Over the past decade, they have performed above average in the Masito survey delivering a quality service but have slipped since 2021.
Conclusion
Some will say the competition has been trying to imitate for years but XPO/ Saia and commentary around share shifts is something I will watch closely as I follow the space.
ODFL management says that post-Yellow’s exit the industry has lost more capacity and less volume. This has typically led to weaker service levels and shifted share towards Old Dominion and they don’t see this time being any different.
Longer term, however, their competitors have likely acquired valuable real estate assets in major MSAs that might allow them to compete more effectively with Old Dominion.
Management
Old Dominion has been family-run until 2023 when Kevin Freeman took the CEO seat from David Congdon. Congdon has stepped back and is now chairman of the board. I think family ownership is exemplified in the firm’s disciplined approach to capital allocation, thinking through the cycle and about profitable long-term growth. Kevin was promoted from within after starting his career with ODFL in 1992.
Insider ownership is pretty high and concentrated primarily in the Congdon family.
Compensation for NEOs comes in the form of; Base Salary, Cash Bonus, RSAs, and performance-based based-RSAs. Cash bonuses are tied to pre-tax income (profitability) and Stock awards rely on operating ratio and pre-tax income growth.
What got you here won’t get you there
We have established ODFL is a superior operator with industry-leading growth and margins but what will be the story of the next 10 years? Can the same playbook be executed to the same effect? I wonder.
Growth
Market Growth
Industrial production in the US has been lackluster partially owing to globalization and the resulting redirection of domestic CAPEX to low-cost economies. Industry volumes have a 0.9 correlation with Industrial Production and 0.73 with US GDP. IY Lagged Durable new goods orders tend to be a strong leading indicator correlating at 0.8. ODFL is ~60%+ industrial so this will be the key driver of growth.
The combined effect of the recently passed infrastructure package and the flourishing theme of reshoring could see elevated domestic growth over the coming 5-7 years. There is a freight multiplier with reshoring where domestic carriers will not only catch the transfer of the finished good but every transportation step between raw material to finished product. The potency of this is hard to forecast but the potential for 100+bps of incremental market growth is very exciting in an industry that is already capacity and concentrated.
Market Share Gains
There is something very unique and intriguing about the graphic below, can you guess what it is? In my short career, I don’t think I can recall another company that competes nationally with such an equal presence. Old Dominion has a strong presence in every region and share gains have come in equal measure. This is incredibly impressive. Typically, in industries requiring a physical presence and large capital investments a competitor will have a stronghold in the east, or the west, making it very hard for new entrants to penetrate. This flows both ways. It may mean that the ‘winner in the East’ will have a hard time establishing a footprint in the West.
With that said, while competition will differ from region to region, ODFL is positioned well to take incremental share nationally. But how much share is there left to capture at their current margin?
Old Dominion caters to a subset of the market that values premium service and is happy to pay premium prices. Presumably, each incremental point of share should be more price-conscious than the last which begs the question, how much room is there to run here? I don’t have an answer to this question. Even my most optimistic self cannot imagine these customers make up more than 20% of the market.
Old Dominion doubled its share in the last 12 years and I do not think this will be a repeatable act without compromising yield. Putting a number on potential further market share gains will be difficult, I would want to speak with the company and its competitors to get a sense of how the key players think about this.
The street is concerned about further share gains post the exit of Yellow which effectively brought forward 10+ years of share gains in a quarter. JP.M estimates ~60-70% of Yellow’s pre-bankruptcy volumes will return to the market. At the initial auction carriers picked up;
XPO Logistics took 28 properties for $870m
Estes Express Lines 24 terminals for $250m
Saia 17 terminals for $240m
Knight-Swift 13 terminals for $51m
Old Dominion management has remarked that the overall industry has not lost demand, just supply. Which should be good for pricing.
Competition for incremental share from Saia/XPO and premium market saturation will be two key things to watch for me in this stock. This concern is really greater for me over the coming 10 years than the next 5.
Pricing
The LTL industry has long been disciplined in passing through costs and raising prices unanimously with annual GPRs.
Ultimately, the exit of a low-cost competitor could institute even greater pricing discipline going forward. This will only be exacerbated by the permanent loss of supply. I feel that the industry dynamics allow us to underwrite a LSD industry pricing CAGR over the long run.
Now, can Old Dominion continue to price 100-150bps ahead of cost and ahead of the industry? The latest Mastio survey indicated that ODFL is now viewed as less cost-competitive than they were 5 years ago. Potentially indicating that they have exercised a large degree of their current pricing power. Without any tangible improvements to be made in service and competitors starting to copy the playbook, I struggle to see how this situation can persist into perpetuity. If Saia and XPO are unable to close the gap on service ODFL will likely continue to take premium share when others miss-step.
Conclusion
Market share gains and pricing power are not of huge concern over the next 3-5 years but I will be watching growth and price vs competitors closely as I track the stock. Market share tends to be flat in a weak economy so we will need to wait for the cycle to turn to evaluate further. Management is adamant that the long-term outlook is rosy with room for share gains and price capture above cost. In the 1Q24 call, they stated their CAPEX plans are done with a good line of sight on demand over a 5-year horizon based on customer conversations.
Through the cycle I expect;
0-1% market growth
LSD share gains
L/MSD pricing gains
Culminating in a M/HSD pricing CAGR.
Margins
People are the largest expense line item at 45% of sales. This is a high-touch business, each load will be loaded and unloaded multiple times and there will be limits to leverage attainable on labor.
On average variable costs are ~2/3 of the total operating ratio, management called out ~53% of sales as variable costs and ~21% as fixed costs.
However, there should still be room to lever fixed assets by adding incremental doors onto existing facilities and density to the network at large.
In a lower growth scenario, we could see management decide to eat into that precious spare capacity they hold for market share gains and the reduction in growth CAPEX elevates FCF.
The Model
Base Case
A LSD pricing CAGR is compounded by modest volume gains in the next cycle
Operating expenses grow at 0.9x the rate of sales, lower than the 10y average of 0.81x
Bull Case
Growth is closer to the long-run average (9.6% 10y avg) on the back of higher cyclical volumes and greater industrial activity
Operating leverage at the historical rate of 0.81x
Bear Case
Growth slips to 2% and remains in the LSD range to encapsulate greater competitive threats and lower growth
No further operating leverage in the model. This bakes in price being in line / below operating costs due to greater competition.
Valuation & Stock Thoughts
The discussion so far has been centered around the long-term opportunity for the business but I now want to spend some time discussing the near-term dynamics in concert with the valuation.
We have been in a long downcycle, exacerbated by the inventory hangover post-COVID.
Bar a single reading in March 2023, ISM manufacturing PMIs have been in contractionary territory since October 2022.
This will end, and market volumes will return but investors need to balance this with incremental supply additions as carriers bring on the capacity they purchased from Yellow in 2023.
Analyst Satish Jindel,;SJ Consulting “LTL is the bright spot in trucking, but they’re ruining it,” says Jindel. “When Yellow went out of business, it took capacity out. But the carriers that benefitted from that, they’re bringing terminals back on line and bringing capacity back on line. It’s starting to look like 2009, which was an awful year for trucking.”
High-quality US stocks rarely come cheap and ODFL is no exception. A portion of prior returns have also been driven by multiple expansion which is unlikely to continue. A recovery in earnings will likely eat into that multiple. I feel more comfortable comparing ODFL on a pre-COVID basis where they had climbed into the 9-13x range since 2014.
If we assume low-teens is a fair run-rate multiple, we do not approach this rate until 2029 in my Bull Case and 2028 on the streets numbers.
ODFL does not look compelling on a TSR basis either. If you assume any normalization in the multiple then the main source of return will come from dividends which I have grown at a 30% CAGR, in line with growth over the last 5 years.
Old Dominion has always traded at a premium to the group which has struggled to garner a double-digit multiple. This helps contextualize the exit multiples in my TSR analysis above, they look punitive but may still be too rich.
Old Dominion is a great operator and I believe in the ability of this business to continue to win long term. However, the cyclical recovery is highly anticipated and already heavily baked into the price so I would not be a buyer at today.
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